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Chapter 1

Introduction of the Project

1.1 Objectives

This report aims

To simplify the concept of mutual funds
To provide basic understanding of mutual funds as an investment tool
To inform about the various regulations laid down for mutual funds
To improve investor awareness about mutual funds

1.2 Scope and limitation

The scope of this project is to study the mutual fund industry and to simplify the core
concepts of mutual funds. The scope also extends to understand the regulatory aspect of
this industry like the investors rights, investment restrictions and so on.
The limitation of this project is that, the study is based on the data available through
various sources like magazines, books, websites etc. Also this study was carried out for a
short duration of two months; therefore it was difficult to cover all aspects of this subject.

Chapter 2
Mutual funds in India

2.1 Defining Mutual Funds

The word mutual funds has two important terms put together. They are mutual and
funds. In mutual funds, the mutuality is achieved through contribution made by
investors in a scheme. This contribution is the fund collected under the scheme which will
invest this money as per the schemes objective. The objective of mutual fund is to provide
investors with a tool for investing the money in such a way that they can provide them
better returns and diversification. Therefore, mutual fund is an instrument of investing
Mutual fund is a professionally managed type of collective investment that collects
money from many investors and puts it in stocks, bonds, short term money market
instruments and/or other securities.

The Security Exchange Board of India (SEBI) defines mutual fund as,a fund established
in the form of a trust to raise monies through the sale of units to the public or a section of
the public under one or more schemes for investing in securities including money market
instruments or gold or gold related instruments or real estate.

The Association of Mutual Funds of India (AMFI) defines it as,a trust that pools the
savings of a number of investors who share a common financial goal. The money thus
collected is then invested in capital market instruments such as shares, debentures and
other securities. The income earned through these investments and the capital
appreciation realised are shared by the investors who are called the unit holders in
proportion to the investment made by them which is calculated in number of units owned
by them. Thus, a mutual fund is the most suitable investment for the common man as it
offers an opportunity to invest in a diversified, professionally managed basket of
securities at a relatively low cost.

Working of mutual fund

[Source:AMFI] Fig.1: Working of Mutual funds

A mutual fund mobilizes the savings of the investors under a scheme. A scheme in
general means a plan of action. Similarly a scheme in mutual fund provides a plan about
where it wishes to invest the collected money. It can be purely on shares or in proportion
to equity and debt etc. The choice of scheme depends upon the investors need. With his
investment in a scheme, he buys units for himself which is issued by the mutual fund.
This collected money under a scheme is called corpus and is managed by the fund
manager who has an expertise in the area of investments backed by research carried out
by the fund houses. The fund manager makes the investments in the stocks or bonds
based on the objective of the scheme and the returns generated are distributed to the
investors in the proportion of the units held by them.

2.2 History of Mutual Fund

In 1774, a Dutch merchant invited subscriptions from investors to set up an investment

trust by the name of EendrangtMaaktMagt(unity creates strength) with the objective of
providing diversification at a low cost to small investors and it proved to be very
successful.This led others to follow suite.

On March 21,1924 the Massachusetts Investor Trust was formed by three Boston
financial executives. This fund is widely seen as the first organised mutual fund and the

one that popularized the concept of mutual fund in the twentieth century.There was
tremendous excitement and interest among the American investors but its popularity
suffered during the great depression in 1929.To win back the confidence of the
investors,powerful market regulations were laid down. The Securities Exchange
Commission (SEC) was setup on June 6,1933.It is a federal agency which holds primary
responsibility for enforcing the federal securities laws and regulating the securities
industry, the nation's stock and options exchanges, and other electronic securities markets
in the United States.

With regulations in place and renewed confidence in the stock market,mutual fund gained
in popularity. Following this many new schemes were launched and new services were
introduced.Presently,United States has more than 11,000 schemes and is a leader in this

Mutual funds in India

The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India, as the initiative of the Government of India and Reserve Bank of India. UTI
launched its first scheme US-64 in July 1964.In the 1st week, UTI received 1,26,000
applications for Rs. 17.4 crores which was a huge amount then.

The UTI functioned under the regulation of RBI which was later on regulated by the
Industrial Development Bank of India (IDBI).The year 1987 marked the entry of the
public sector mutual fund which was setup by the public sector banks and Life Insurance
Corporation of India (LIC) and General Insurance Corporation of India (GIC).During the
early 1990s the Indian capital market had excess of funds.As economic reforms were
being initiated in the country, the stock market boomed resulting in large investments in

However,in 1992 Harshad Mehta scam shook the stock market which showed a decline in
mutual funds as the investors lost confidence.The government took three major initiatives
to win back the investors confidence
i. The Securities Exchange Board of India (SEBI) was setup to regulate the capital market.
ii. Private and Foreign players were allowed to run mutual funds.

iii. Mutual fund regulations were re-designed to make fund house more accountable.
At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 a

Also the private sector funds started in 1993 gave the Indian investors a wider choice of
fund families. The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was
the first private sector mutual fund registered in July 1993.The 1993 SEBI (Mutual Fund)
Regulations were substituted by a more comprehensive and revised Mutual Fund
Regulations in 1996. The industry now functions under the SEBI (Mutual Fund)
Regulations 1996.The number of mutual fund houses went on increasing, with many
foreign mutual funds setting up funds in India and also the industry has witnessed several
mergers and acquisitions.

In February 2003, following the repeal of the Unit Trust of India Act 1963, UTI was
bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of
India with assets under management of Rs.29,835 crores as at the end of January 2003,
representing broadly, the assets of US 64 scheme, assured return and certain other
schemes. The Specified Undertaking of Unit Trust of India, functioning under an
administrator and under the rules framed by Government of India and does not come
under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund, sponsored by State Bank of India, Punjab National
Bank, Bank of Baroda and LIC. It is registered with SEBI and functions under the Mutual
Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000
more than Rs.76,000crores of assets under management and with the setting up of a UTI
Mutual Fund, conforming to the SEBI Mutual Fund Regulations.
Presently, mutual funds in India provide more than 1000 schemes and are in the current
phase of consolidation and growth.

Growth of Asset under management

[Source:AMFI] Fig.2:Growth of asset under management

Investor Contribution as on March 2011

In crores
Corporates Banks FII Retail HNI
24% 44%


1% 4%
[Source:AMFI] Fig.3: Investors contribution

2.3 Structure of Mutual fund




Fig4: 3 Tier Structure of Mutual fund

Mutual Funds in India follow a 3-tier structure.

1. First Tier: Sponsor

A sponsor as defined by the regulation is any person who, acting alone or in combination
with another body corporate, establishes a mutual fund
The sponsor thinks of starting a mutual fund. He must be a fit and proper person.
The sponsor approaches the Securities & Exchange Board of India (SEBI), who is the
market regulator and also the regulator for mutual funds. SEBI checks whether the person
is of integrity, whether he has enough experience in the financial sector, his networth etc.
The sponsor is required to obtain a license from SEBI.
The sponsor has to contribute at least 40% of the net worth to the asset management
company. The sponsor takes decision related to mutual fund, leaving money management
and other operational issues to those given specific responsibility or assigned to specific

2. Second Tier: Trustees

Once SEBI is convinced, the sponsor creates a Public Trust1 as per the Indian Trusts Act,
1882. A trust is created through a trust deed. Trusts have no legal identity in India and
cannot enter into contracts, hence the Trustees are the people authorized to act on behalf
of the trust. Trustees mean Board of trustees or Trustee Company who hold the property
of mutual fund in trust for the benefit of the unitholders. Contracts are entered into in the
name of the trustees. Once the trust is created, it is registered with SEBI after which the
trust floats mutual funds.

The trust deed shall contain clauses necessary to safeguard the interest of the unit holders.
No trust deed shall contain a clause which has the effect of-
i. Limiting or extinguishing the obligation and liabilities of the trust in relation to any
mutual fund or the unitholders; or
ii. Indemnifying the trustees or the asset management company for loss or damage caused to
the unitholders by their acts of negligence or acts of commission or omission.

A trustee should be a person of ability,integrity and standing. And he should have not
been found guilty of moral turpitude and should have not been convicted of any economic

The trustees role is not to manage the money. Their job is only to see, whether the money
is being managed as per stated objectives. Trustees may be seen as the internal regulators
of a mutual fund.

When more than one trustee is appointed they would constitute a board of trustees.A
company can be appointed as a trustee.Such a trustee like any other company would have
board of directors.No person who is a trustee of a mutual fund can be appointed as the
trustee of any other mutual fund.However, if a company is appointed as a trustee then its
directors can act as trustees of any other trust provided that the object of the trust is not in
conflict with the object of the mutual fund.
Also a mutual fund must have minimum of four trustees and two-third of the trustees
must be independent trustees.

3. Third Tier: Asset management company(AMC)

Every mutual fund has to have an AMC. Trustees appoint the Asset Management
Company (AMC), to manage investors money. The AMC in return charges a fee for the
services provided and this fee is borne by the investors as it is deducted from the money
collected from them. The AMCs Board of Directors must have at least 50% of Directors
who are independent directors. The AMC has to be approved by SEBI. The AMC
functions under the supervision of its Board of Directors, and also under the direction of
the trustees and SEBI. It is the AMC, which in the name of the trust, floats new schemes
on approval from the trust and manages these schemes by buying and selling securities. In
order to do this the AMC needs to follow all rules and regulations prescribed by SEBI and
as per the Investment Management Agreement it signs with the trustees. An AMC can be
terminated by majority of trustees or by seventy five per cent of the unit holders. Also an
AMC is required to have a networth of not less than rupees ten crores. Presently in India
we have 51 mutual fund houses registered with SEBI out of which 41 fund houses are

New Fund Offer

Once the three tier structure is in place, the AMC proposes schemes and if approved by
the trust, the new scheme is floated under the name of the trust. Initially, a draft of the
offer document is to be sent to the SEBI and if it gets approved it is offered to public as a
new fund offer. Investors who invest in the fund offer have to carefully read the offer
document and then invest. Based on the money invested they subscribe to its units. As per
regulation, all new fund offers except for equity linked saving schemes shall be open for
subscription for a period of 15 days. Also, the allotment of units or refund shall be done
within 5 working days. The trustees have to ensure that the name of the scheme approved
by them is a new product offered by mutual fund and is not a minor modification of the
existing schemes.

The other important entities in the Mutual Fund structure are:

i. Custodian
ii. Registrar and Transfer Agent
iii. Distributors

A custodian is responsible for the safe keeping of the physical securities and also keeping
a tab on the corporate actions like rights, bonus and dividends declared by the companies
in which the fund has been invested. The custodian is appointed by the Board of Trustees.
The custodian also participates in a clearing and settlement system through approved
depository companies on behalf of mutual fund, in case of dematerialized securities. The
deliveries and receipts of units of a mutual fund are done by the custodian or a depository
participant at the instruction of the AMC and under the overall direction and
responsibility of the trustees. Regulations provide that the sponsor and the custodian must
be separate entities.

Registrar and Transfer Agent

Registrars and Transfer Agents (RTAs) perform the important role of maintaining
investor records. All the New Fund Offer (NFO) forms and redemption forms go to the
RTAs office where the information is converted from physical to electronic form. How
many units will the investor get, at what price, what is the applicable NAV, what is the
entry load, how much money will he get in case of redemption, exit loads, folio number,
etc. is all taken care of by the RTA.

Distributors are responsible for the distribution of mutual fund schemes to investors. As
per AMFI(Association of Mutual Fund), they need to pass the Mutual Fund(Advisor)
Module Test and register with AMFI for an AMFI registration number(ARN) before they
can operate as an advisor. And according to SEBI, only registered intermediaries can be
paid brokerage.

2.4 Schemes in mutual funds

There are various schemes offered to an investor who can invest in them based on their
investment objectives and risk profile. The mutual fund offers schemes that cater to
different investor needs.

They are classified as,
By structure
Open-ended schemes
Close-ended schemes
Interval schemes

By investment objective
Growth schemes
Income schemes
Balanced schemes
Money Market schemes

Other schemes
Tax saving schemes
Special Schemes
Index schemes
Sector schemes/ Thematic schemes
Exchange Traded Funds

Open ended schemes

These schemes can be subscribed throughout the year. The investor can purchase the units
at its prevailing net asset value from the fund house directly or through the stock
exchange. Although the stock exchange platform is yet to gain popularity. Also in case to
redeem the units, they are repurchased by the mutual fund house at the current net asset
value(minus exit load, if any) which is opened throughout the year except during the
period of book closing2.
There is no fixed number of units issued and they have no fixed maturity period.

Close ended schemes

These schemes have a fixed maturity period. These schemes are opened for subscription
for a specified period. SEBI has mandated that they invest in only those schemes that
mature on or before the maturity of the scheme. Once the investor invests in these funds
they are listed in the stock exchange where they can buy or sell these units from/to other
investors. Sometimes, close ended funds also offer buy-back of fund units, thus offering
another avenue for investors to exit the fund. Therefore, regulations drafted in India
permit investors in close ended funds to exit even before the term is over. Here the
investors are required to have a de-mat account to hold the units.

Interval schemes
Interval funds combine the features of open and close ended funds. They are open for sale
or redemption during pre-determined intervals at net asset value based price.

Growth schemes
The aim of this scheme is to provide capital appreciation over medium to long
term.These schemes invest majorly in equities.They are suitable for young investors and
investors who wish to wait for longer period and have no regular income requirements.

Income schemes
The aim of this scheme is to provide regular income therefore they invest majorly in debt
instruments. Investors with less risk appetite and who wish to seek regular income can opt
for these schemes. Capital appreciation is secondary is such schemes.

Balanced schemes
The aim of this scheme is to provide growth and income to the investors. They invest both
in debt and equities in different proportion.A typical equity/debt mix in a balanced fund
could be 40:60 that is 40% in equity and 60% in debt .This fund is ideal for investors
looking for a combination of income and moderate growth.

Money market schemes

These funds provide easy liquidity, preservation of capital and moderate income. They
are low risk as they invest in short term money market instruments such as treasury bills 3,
certificate of deposit4, commercial paper5 and inter-bank call money6.These funds are for
corporates and individual investors to park their short term surpluses.

Tax saving schemes

These schemes offer tax benefit to the investors .The idea is to promote long term
investments in equities through mutual funds.

Equity linked saving schemes(ELSS) is equity funds that come in with income tax
benefits to individuals. An investment in ELSS can be deducted from income under
section 80C of Income Tax Act where the investors can claim upto Rs. 1 lakh as

Index schemes
These schemes replicate the popular stock indices like Nifty 50 and invest in stocks in
same proportion as in the index. Index funds never attempt to beat the index returns, their
objective is always to mirror the index returns as closely as possible.The difference
between the returns generated by the benchmark index and the index fund is known as
tracking error. By definition, Tracking Error is the variance between the daily returns of
the underlying index and the net asset value of the scheme over any given period.These
schemes involve low risk and low cost.

Sector schemes/Thematic schemes

Funds that invest in stocks from a single sector or related sectors are called Sector
schemes. Examples of such schemes are IT Funds, Pharma Funds,Infrastructure Funds,
etc. Regulations do not permit funds to invest over 10%of their net asset value in a single
company. This is to ensure that schemes are diversified enough and investors are not
subjected to undue risk. This regulation is relaxed for sector schemes and index
schemes.High concentration on a particular sector makes these funds very risky.They are
also known as thematic schemes.

Exchange Traded Funds

These funds are traded on the stock exchange by the Authorised Participants who may
quote a buy and sell price. Here the AMC doesnt have to directly deal with the investors
or the distributors.

2.5 Mutual fund terminology

Asset Under Management (AUM)

The money invested in a scheme by the investors is called the asset under management.
This money is available for investment. The fund invests this money in various securities
in line with its stated objective.
AUM is calculated as,
AUM= Net asset value * No. of outstanding units

Net asset value (NAV)

Net asset value is the market value of the asset minus any liabilities.It is the value of each
unit of the scheme.

NAV is calculated as,

NAV= (Total assets Total liabilities)/Number of outstanding units

In an open ended fund the units are purchased or sold on the NAV of the units.
NAV has to be rounded to 4 decimal places for index fund and 2 decimal places for
equity and balanced funds.

Load is the charge that is applied while purchasing or redeeming the units.There are 2
loads one is the entry load and the other is the exit load. Entry load is applied while
purchasing the units and this is charged for making the service available. Because of this
load the number of units that an investor gets is less in comparison with no load
structure.As per SEBIs regulation from 1st August 2009 onwards, there shall be no entry
load on purchase of the units so that the investors can get full benefit of their investment.
Exit load was introduced to encourage the investors to stay invested for a long duration.
Contingent Deferred Sales Charge (CDSC) is a modified form of exit load where the
investors pay different exit load depending upon the investment period.As per SEBIs
regulation from 1st August 2009 onwards, not more than 1% can be charged as exit or
CDSC load.

A mutual fund issues units to the investors on the investment he makes in a particular
scheme.The number of units issued depends upon the money invested and the net asset
value of the unit. As per SEBI, unit means the interest of the unitholders7 in a scheme
which consists of each unit representing one undivided share in the assets of a scheme.

Expense ratio
The expense incurred by the fund house for managing the invested money is borne by the
investors. SEBI permits equity schemes to charge up to a maximum of 2.5% of the corpus
as expense.Debt schemes are permitted to charge upto 2.25% as expense on the corpus.
The limit is as follows,
First Rs. 100 crores:2.5%
Next Rs. 300 crores: 2.25%
Next Rs. 300 crores: 2%
On the balance of the assets: 1.75%

The 2.5% slab is made up of

Investment management fees:1.25% for upto Rs. 100 crores of average weekly NAV and
1% if above Rs. 100 crores of average weekly assets.
Custodial fees: 0.50%
Shareholder servicing fees:0.50%
Trustees remuneration, audit fees etc.:0.25%
Total is 2.25%

Expense ratio is calculated as,

Expense = Expenses incurred by the scheme/Average weekly NAV

This gives how much of the investors money goes out as expense and how much is
getting invested. As the net asset goes up,the expense ratio should come down.
The expense ratio helps in
i.Peer comparisons
ii. For comparing schemes own expenses at different point of time.

Portfolio turnover ratio

This ratio tells how aggressively the portfolio is being churned. Churning involves
transaction cost which is borne by the investors. Transaction cost involves buying and
selling price of shares by way of brokerage,STT,cess etc.

Portfolio Turnover =Less of assets bought or sold/Net assets

Eg.100 crores is the net asset and 20 crores is the investment sold, then 20/100 ie 20% is
the portfolio turnover .If entire portfolio is churned in a year then the portfolio turnover
ratio is 100%

Cash level in portfolio

Cash level is the cash in hand of the mutual fund which is not invested.Typically 3-5%
cash may be held and 95-97% is invested.Cash level is needed to meet the needs of
redemption in case of open ended schemes.

Fund Fact sheets

After an investor enters into a scheme he should monitor it through Fund Fact sheet.The
fund fact sheet is a monthly document which all mutual funds have to publish. The
important aspects present in a fund fact sheet are AUM of all its schemes, performance
over 1,3,5 years and also since launch, load, top holding, minimum investment,
comparison of performance with benchmark index.

A benchmark is an underlying against which the investment return is compared. This
underlying can be the Nifty ,S& P, CNX etc. If the investment return is greater than the
benchmark return we say that the fund has outperformed its index.

Sale Price
It is the price at which the units are available for purchase.
Sale Price = Applicable NAV

Repurchase Price
It is the price at which the units of the open ended schemes are purchased back by the
fund house.
Repurchase Price = Applicable NAV *(1-Exit Load, if any)

Redemption Price
It is the price at which the units of the close ended schemes are redeemed on maturity.
Such prices are NAV related.

Cut-off time
It is the time limit provided to determine which NAV will be applicable for the purchase
or redemption request of units. For schemes if the purchase or repurchase request is
received before 3 pm then the closing NAV of that day will be applicable. In case the
request is received after 3 pm then the closing NAV of the next business day will be

2.6 Advantages of mutual fund

Low cost involved

To invest in a stock which is a risky asset not only good knowledge is required but also
sufficient funds are required. For example one share may cost Rs 400 but in case of
mutual fund NAV can be as low as Rs 10 if its a new fund offer. Such a small sum can
give flexibility on how much sum should be invested. This is comparatively cheaper than
capital market investment because it enjoys the large scale of investors under one scheme.

Professionally managed

If its a nave investor with no knowledge of the capital market then mutual fund provides
with professional managers. These fund managers are backed by research team which
help them in choosing good investments.


Mutual fund allows choosing diverse portfolio. One can opt for different schemes that
invest in diverse sector and can choose between less risky to risky investments. An
investor can also invest in commodities like gold.

Well regulated

Mutual fund operates under the purview of SEBI. This regulatory body keeps amending
policies to make mutual fund industry more transparent and investor friendly.

Tax benefit

Mutual fund provides tax benefits on long term capital gains in equity schemes. Also, the
dividend received to the investors is tax free.


The presence of open ended schemes allows the investors to invest as well as opt out as
and when required. Also the close ended schemes allow them to be traded on stock
exchange providing good liquidity. A huge number of investments come from the
corporate sector followed by banks,retailers,high net worth investors and household.

Basket of schemes

Mutual fund provides with many choices regarding schemes and investor can compare
and choose these schemes across the mutual fund houses.


SEBI regulations have helped make this industry more transparent to the investors. As per
the regulation they have to provide the investors with fund fact sheet every month, half
yearly unaudited report and annual report. Also any fundamental changes have to be
informed to the investors and they are to be provided an exit option without charging any
exit load.

Chapter 3
Investment in Mutual funds

3.1 Meaning: Investment need and Investment objective

Money has always been an important element in everyones life. People save money to
fulfil their various needs like buying a house to buying a car or other responsibilities like
saving for their childrens education and marriage.
Also people save for their retirement. Therefore they look in for opportunities where these
savings can be invested to produce great returns.
In brief,the purpose of investment is to enable people realise their goals and invest
Investment requires 2 things
Investing early has its advantage as it helps take the benefits of compounding therefore
increases returns. Also investing regularly helps in taking advantage of the market during
its low phase.
Before starting to invest determine the objectives and accordingly invest in schemes.
Also while investing think from long term perspective. Diversifying investment reduces
the risk exposure. Investors need to understand the kind of risk they are ready to take
before investing. Starting early provides an advantage of age as they can take higher risk
than people who have obligations towards their family.
Equity is seen to provide inflation compensating returns but it involves higher risk too.
This is because the market keeps on fluctuating.Therefore an investor can diversify his
portfolio by investing in stocks,bonds,money market instruments and gold in proportion
based on his risk taking ability. A small exposure to gold helps in providing hedging
against any price rise.
John Bogles thumb rule for investor is that as per age invest in debt instrument.
Eg if an investor is of 40 years he should invest 40% in debt and 60% in equities.

3.2 Debt, Equity and Liquid schemes

Debt Schemes
Debt schemes invest money majorly in debt instruments like bonds,government
securities,commercial paper,certificate of deposits and call money etc.

Main objective of debt funds are

preservation of capital
generation of income

Here performance against benchmark is considered secondary.

Debt schemes are considered safer and less volatile. Investors can participate through debt

At first sight debt schemes look less risky but there involves 2 kinds of risk

i. Interest rate risk

ii. Credit risk

i. Interest rate risk

If an investment is blocked in a debt instrument for a long period and in case the interest
rate rises, the investor wont be able to take advantage of the increased interest rate.

Example: If an investor invests in a bond at 12% interest rate having a maturity period of
3 years then after 2 years if the interest rises to 14% the investors cannot take advantage
of the increased interest rate as there is one more year for the bond to mature. Therefore,
the investor faces an interest rate risk here.

ii. Credit risk

Also there involves the risk of default in paying the interest (income loss) and there also
involves the risk of non-repayment of the principal (absolute loss).Credit rating from
ICRA, CRISIL8 helps in avoiding lending money to corporates with high default risk or
low rating i.e. speculative grade. That means they have higher yields but have a higher
risk of default on the part of the issuer.

Example: If ICRA provides a rating of A1 to a short term debt instrument of a company
that means it has the lowest credit risk or low risk of default.

Pricing of debt instruments

The price of an instrument (equity/bond) is nothing but the present value of future cash
Future cash flow in case of bonds is periodic coupon payment that the investor will
receive. Future cash flow for equities is the dividends that the investors may receive.
Present value of future cash flow can be calculated as follow,

Discounting method:


Where P ->principal at the present value

A->amount of future cash flow

r->discounting rate

n->number of years

Example: If A=215.89 at r=8% for n=10 years then P=100

Yield to Maturity(YTM)

It is the rate of return anticipated on a bond if it is held until the maturity date. It reflects
all the interest payments that are available through maturity and the principal that will be
repaid. Therefore YTM is considered a long-term bond yield expressed as an annual rate.
The calculation of YTM takes into account the current market price, par value, coupon
interest rate and time to maturity. It is also assumed that all coupons are reinvested at the
same rate. Sometimes this is simply referred to as "yield" for short.

Yield to Maturity and Present Value of a Bond

The yield to maturity is found in the present value of a bond formula:

c(1 + r)^-1 + c(1 + r)^-2 + . . . + c(1 + r)^-Y + B(1 + r)^-Y = P.

c-> Annual coupon payment
B->Par value
P->Purchase value
r -> rate of return
For calculating yield to maturity, the price of the bond, or present value of the bond, is
already known. Calculating YTM is working backwards from the present value of a bond
formula and trying to determine what r is.

If a bond is selling for Rs. 980, with a coupon rate of 8 percent, maturing in five years,
what is the YTM? The par value is Rs. 1,000. The coupon payment is Rs. 80 (that's 8% of
Rs. 1,000).

The equation is: 80(1 + r)^-1 + 80(1 + r)^-2 + 80(1 + r)^-3 + 80(1 + r)^-4 + 80(1 + r)^-5
+1,000(1 + r)^-5 = 980.

In this example, the YTM equals 8.508 %

This is the most valuable measure of yield because it reflects the total income that an
investor can receive.

Bond price and interest rate

Also an important point to understand is the relationship between bond price and interest
Bond price and interest rates are inversely related. If the interest rate goes up the bond
prices come down, similarly if interest rates goes down the bond prices goes up.
For instance, if a zero-coupon bond is trading at Rs.950 and has a par value of Rs1,000
(paid at maturity in one year), the bond's rate of return at the present time is
approximately 5.26% ((1000-950)/950 = 5.26%).

For a person to pay Rs.950 for this bond, he or she must be happy with receiving a 5.26%
return.But if the current interest rates were to rise, giving newly issued bonds a yield of
10%, then the zero-coupon bond yielding 5.26% would not only be less attractive, it
wouldn't be in demand at all. Therefore to attract demand, the price of the pre-existing
zero-coupon bond would have to decrease enough to match the same return yielded by
prevailing interest rates. In this instance, the bond's price would drop from Rs.950 (which
gives a 5.26% yield) to Rs.909 (which gives a 10% yield).
1000-x=.1x, x=909

Therefore,here as the interest rates went up, the bond prices have come down.

Similarly, now if the rates dropped to 3%, the zero-coupon bond with its yield of 5.26%
would suddenly look very attractive. More people would buy the bond, which would push
the price up until the bond's yield matched the prevailing 3% rate. In this instance, the
price of the bond would increase to approximately Rs.970. Given this increase in price, it
can be seen that bond-holders (the investors selling their bonds) benefit from a decrease
in prevailing interest rates.
1000-x=.03x, x=970

Debt mutual fund schemes

1. Fixed maturity plan(FMP)

This is a close ended scheme. The fund manager buys debt securities whose maturity
period coincides with the maturity of the scheme. If FMP gives higher indicative yield
then it involves higher risk too. High risks because the fund manager may be investing in
securities that have high default risk. Indicative yield are pre-tax and investors will get
less returns after the tax is deducted. However, SEBI has restricted mutual fund from
providing any indicative yield.

2. Capital protection funds

This is a close ended scheme and the fund manager invests in both debt and equities or
derivatives9. Some portion of investors money is invested in debt instrument like
government securities to provide capital protection and remaining is invested in equities
for capital appreciation. This scheme has been designed to protect the capital invested
therein through suitable orientation of its portfolio structure.

3. Gilt funds
In these funds, the fund manager invests only in government securities of central and state
government. Here there is no credit risk present but interest risk still prevails.

4. Balanced funds
In these funds they invest in both debt and equities in different proportion to provide
income and growth. Balanced does not necessarily mean 50:50 ratio between debt and
equity. There can be schemes like MIPs or Children benefit plans which are
predominantly debt oriented but have some equity exposure as well.

5. Monthly income plan (MIP)

Monthly income plan are hybrid funds that provide regular income to investors. Debt
instrument provides monthly income through interest returns and equity provides income
through dividend which may or may not be given.

6. Child benefit plan

These are debt oriented funds with very little exposure to equity. The objective of this
fund is to provide capital protection and steady appreciation.

7. Floating rate funds

In these funds the coupon of the securities is adjusted according to the changes in the
interest rate. If the interest rate goes high so does the coupon and the increase is to the
level of the new interest rates. Therefore, there is no reason for the price of the paper to
fall; here the investor is compensated by getting higher coupon. There is no interest rate
risk present. Since, the interest rate floats it is called as floating rate funds.

8. Junk bond funds

These invest in securities that have low credit rating involving high risk. SEBI limits the
investment in unrated securities and in those below investments grade upto 25% of NAV
of any scheme.
Example: The speculative grade provided by ICRA, CRISIL are called junk bonds.

Equity Schemes

In equity schemes, the fund manager invests in shares of companies with good future
prospects. Investing in share involves high risk as the share price keeps fluctuating but at
the same time it may provide high returns.

Equity funds are defined as those funds which have at least 65% of their average weekly
net assets invested in Indian equities. This is important from the tax point of view.

Safer types of equity funds are

Index funds
Diversified large cap funds

Riskier varieties are

Sector funds

Equity funds on basis of market capitalization

Large cap funds

Mid cap funds
Small cap funds

On basis of Investment strategy

Index fund
Infrastructure fund
Power sector fund
Quant fund
Arbitrage fund
Natural resources fund etc.

Sector schemes and index schemes have been mentioned earlier. These are also known as
sector funds and index funds. The other equity funds are discussed below.

1. Diversified Large cap fund

Here the fund manager restricts the stock selection to the large cap stocks-typically top
100 or 200 stocks with highest market capitalization and liquidity.
Large cap stocks are those who have a market capitalization10 of more than
Rs.10000crores. They have sound business, strong management, globally competitive
products and are quick to respond to market dynamics.

These are actively managed funds where fund manager looks in for the company
information, researches the company, analyses market trends and is unlike an index fund
which is passively managed.The expenses involved here are higher in comparison to
index fund.

Similar to large cap, midcap fund has market capitalization of Rs. 500 10,000 crore and
a small cap fund has market capitalization of less than Rs.500 crore.

Many of these midcaps are said to be the emerging bluechips or tomorrows large
caps. These can be either actively managed or passively managed mid cap funds.

Also as stock selection increases from midcap to small cap risk level increases with
respect to the previous category. The logic is higher the risk, higher is the returns

2. Arbitrage funds

These invest simultaneously in the liquid and the derivatives market and take advantage
of the price differential of a stock and derivatives by taking opposite positions in the two
markets(for e.g. stock and stock futures).

3. Multicap funds

These funds can, theoretically, have a smallcap portfolio today and a largecap portfolio
tomorrow. The fund manager has total freedom to invest in any stock from any sector.

4. Quant funds

Quant or computer driven funds make use of mathematical model to decide in which
stock to invest.Here the system is the fund manager as the system throws buy and sell

5. P/E ratio funds

P/E ratio is given as Market price per share/Earnings per share.Typically a fund manager
will invest in a company with a low P/E multiple and sells them when it reaches an upper

6. Growth schemes

As explained earlier, growth schemes looks for capital appreciation.

7. Contra funds

These funds are also known as value schemes. They buy a stock that is undervalued today
and as the price moves up exit and search for another undervalued opportunity. To cite an
example when interest rates are high people defer borrowing at high cost. This pushes the
stock price of the company down, so these stocks are purchased by value investors as they
believe when interest rates will come down, the stock prices of those companies will
increase. Therefore, they take a contrarian call.

8. Equity linked saving schemes

These are open ended schemes but have a lock in period of 3 years.This scheme provides
income tax benefit upto 1 lakh under Section 80C of Income Tax Act.

9. Fund of Funds

The fund manager doesnt invest directly in stocks and bonds. Instead they invest in units
of other mutual fund schemes or in the schemes of the same fund house which they
believe will perform well and generate high returns.

Eg-FT India Dynamic PE Ratio fund of funds, Kotak Equity fund of funds are some fund
of fund schemes.

Liquid schemes

Liquid funds attract a lot of institutional and HNI money. It accounts for approximately
40% of Industry AUM. They are less risky and provide better returns than a bank current

Money market refers to debt market with securities having less than 1 year maturity.
These include treasury bills, collateralised borrowing and lending obligation11, interest
rate swaps12, commercial papers, certificate of deposits and so.
Liquid Funds (also known as Money Market Mutual Funds) make investment in debt and
money market securities with maturity of up to 91 days only.
These schemes dont carry any interest rate risk as their maturity period is small. Also
liquid funds do not carry entry/exit load, other recurring expenses are kept to a base

No mutual fund scheme is allowed to invest more than 30% of its net assets in money
market instrument of a single issuer. These limits do not cover instruments in government
securities, T-bills and CBLO.

SEBI has bought in rules to standardize the process of valuation of debt securities and
changed it to reflect the market price. All money market and debt securities including
floating rate securities with residual maturity of upto 91 days are now valued at the
weighted average price at which they are traded on a particular day.
Example: If a T- bill is traded at different point of time on a particular day as,
Volume: 1000, 1100, 1200
Price (in Rs) :98, 97, 96
Then its weighted average is calculated as (price*volume)/volume
Therefore, we get the value as 96.93
If they are not traded on a particular day then they shall be valued on amortization basis
(cost plus accrued interest)

Money market securities that have maturity of less than 182 days is valued using the
Cost plus Interest accrued method

Example:A 90 days commercial paper has a face value as Rs 91 and redemption value as
Rs. 100.Here we can see Rs. 9 is paid as interest over 90 days commercial
paper.Therefore per day works upto 10 paise.If a person redeems on the 35thday,then he is
paid 35*.10=3.5,3.5+ 91= Rs. 94.5

Mark to market

This is an activity where a portfolio profit/loss is calculated on a daily basis on the current
market price.

Example: If a security is purchased for Rs.250 and after 1 day the price increases to
Rs.255 then we say there is a profit of Rs 5 on the security.

All equity and debt securities are marked to market except debt instruments of maturity
less than 182 days.

Liquid schemes invest in securities of less than 91 days maturity. Therefore, a short term
money market benchmark like NSEs MIBOR or CRISIL LiquiFEX is suitable.

Some of the other important aspects of liquid funds are:

They have extremely high portfolio turnover due to shorter maturity period
Liquid fund sees a lot of inflow and outflow on a daily basis. Investors are seen opting for
options like daily or weekly dividend.
As in equities, we have different index for largecaps, midcaps & smallcaps. Similarly in
bonds we have indices depending upon the maturity profile of the constituent bonds. Thus
for a portfolio comprising of long term bonds, we have the Li Bex, for the midterm bond
portfolio, we have the MiBex and for the Liquid Funds we have the Si Bex as the
underlying indices.
Money Market Mutual Funds / Liquid Schemes are taxed @ 25% plus other charges

3.3 Exchange Traded Funds (ETF)

Exchange traded funds are mutual fund units which the investors buys or sells from the
stock exchange as against a normal mutual fund unit. ETFs involve lesser cost as
compared to mutual fund schemes.

ETF structure:

The AMC do not have to deal directly with investors or distributors. Instead the AMC
issues units to a few designated large participants, who are also called as Authorised
Participants (APs). The Authorised Participants provide two way quotes for the ETFs on
the stock exchange, which enables investors to buy and sell the ETFs at any given point
of time when the stock markets are open for trading. Buying and selling ETFs is similar to
buying and selling shares on the stock exchange. Prices are available on real time and the
ETFs can be purchased through a stock exchange broker just like one would buy / sell
shares. There are huge reductions in marketing expenses and commissions as the
Authorised Participants are not paid by the AMC, they earn through the difference
between buy and sell quote.

Index ETF

An index ETF is one where the underlying is an index, say Nifty. The APs deliver the
shares comprising the Nifty, in the same proportion as they are in the Nifty.In exchange
of these shares the AMC provides them with bundled units. These bundled units are

called creation units. And individual units are traded on the stock exchange where they
are listed. Example: 1 creation unit= 100 ETF units.
So each ETF unit will be traded individually. ETF requires an investor to have a trading
account and de-mat account.

The APs provide with a buy and a sell quote for buying and selling the ETF on stock

The difference between the Index fund and Index ETF is the expense involved. If for
example the expense involved in Index fund is 1.5% then in Index ETF it would be
around 0.75%

Gold ETF

Gold ETF invests in gold and gold related securities.In Gold ETF it traces the price of the
gold as the benchmark. The Gold ETF is traded on the stock exchange. Here investors
buy units backed by gold. Thus, everytime an investor buys 1 unit of Gold ETFs, it is
similar to an equivalent quantity of gold being earmarked for him somewhere.
The advantages of Gold ETF are:-

No wealth tax to be paid but the investors may have to borne other taxes.
As the investor holds gold in paper form, they have saved the expense of keeping the gold
in a locker.
Also there is no fear of theft of gold.

Way gold ETF works:

i. New fund offer

AMC launches Gold ETF
Investors give money to AMC who provides units to investors in return.
AMC buys gold of specified quality from investors money.

ii. On-going basis

APs give gold/money to AMC
AMC provides bundled units to APs
APs split the bundle into individual units and offer to sell in secondary market
Investors can buy Gold ETF from APs or retail investors on the stock exchange.

The gold which the APs deposits for buying bundled ETF units is called portfolio
deposits. This physical gold is deposited with the custodian and an agreement is signed
between the custodian and the AMC.As this Gold ETF is traded everyday on the stock
exchange the custodian maintains an account called Allocated account. This account
keeps the record of all the gold that has been deposited or withdrawn under the Gold ETF.

Also a cash component may be present. This is the money the APs deposit for buying
ETF units.This is paid to adjust the difference between the applicable NAV and the
market value of the portfolio deposit.

An example of the gold ETF,

If the last traded price of a Gold ETF is Rs. 1000, then an AP will give a two way quote
by offering to buy an ETF unit at Rs. 999 and offering to sell an ETF unit Rs. 1001. Thus
whenever the AP buys, he will buy at Rs. 999 and when he sells, he will sell at Rs.1001,
thereby earning Rs. 2 as the difference. It should also be understood that the impact of
this transaction is that the AP does not increase/ decrease his holding in the ETF. This is
known as earning through Dealer Spreads.

Also some other points to look into for Gold ETF is that the custodian charges fees for the
service provided. Also they have to buy insurance for the gold held under them. The
premium paid for the insurance is borne by the scheme as transaction cost and is allowed
as an expense under SEBI.

The price of Gold ETF is determined by the market forces and it may not mirror the exact
movement of price of gold from time to time. The difference between the returns given by
gold and those delivered by the scheme is known as Tracking Error. It is defined as the
variance between the daily returns of the underlying (gold in this case) and the NAV of
the scheme for any given time period.

Difference between Gold ETF and Gold Fund

In gold funds, the money is invested in companies belonging to gold sector. This covers
usually those companies that are involved in the gold mining area and hence the
movement or the returns of this fund will depend upon the movement of the companies on

the stock exchange. The base for these schemes is different and hence they have to be
analysed separately.

Unlike a Gold ETF, which shows a direct relationship with the price of gold, the same
might not be witnessed in gold funds. The scheme will show some gains when the gold
companies record higher profits and gains.

3.4 Investment options

Mutual fund offers investment option on each of its schemes they are,
Growth Plan
Dividend payout Plan
Dividend reinvestment Plan

Growth Plan
Investors looking for capital appreciation can go for growth plan. If an investor doesnt
want regular income and is looking for growth this option is apt for him.
For example: if a person aged 25 years invests Rs. 1 lakh in a scheme that has an NAV as
Rs 100, he will get 1000 units.Now at the end of the year if the scheme is able to earn
10% returns then his invested amount grows to Rs.1.1 lakh.That means the NAV of the
scheme has become Rs. 110.Note here that the number of units doesnt change only the
NAV changes due to market fluctuation. And capital appreciation is achieved through the
increase in NAV.

Dividend payout Plan

Investors looking for income can opt for dividend payout plan. In this plan, the increase in
NAV is given out as dividend to the investors and not reinvested.
For example: If the investor purchased 1000 units at NAV=100 and after a year the NAV
increases to Rs. 112, then the investor will get 12* 1000=Rs.12000 as dividend at the end
of the year. And the NAV comes back to Rs 100 again.
The disadvantage of this plan is that as reinvestment doesnt take place, investors cannot
take the advantage of compounding13 which increases their invested amount.

Dividend reinvestment plan
In this plan instead of distributing the dividend to the investor, it is reinvested such that
the number of units increases. Taking into consideration the example in dividend payout
plan, the investor is getting Rs.12000 as dividend. Here, this Rs.12000 is converted to
units ie Rs.12000 is divided by NAV of purchase that is Rs. 100 which converts to 120
units. These units are added to the previously held units totalling it to 1000+120 which
makes it 1120 units. But to note here is that the NAV comes back to Rs. 100.

It must be noted that in equity schemes there is no Dividend Distribution Tax, however
for debt schemes; investor will not get Rs. 12000 as dividend, but slightly less due to
Dividend Distribution Tax. In case of Dividend Reinvestment Option, he will get slightly
lesser number of units and not exactly 120 due to Dividend Distribution Tax.

3.5 Investment plans

Mutual fund offers a systematic way of investing in mutual fund

Systematic Investment Plan
Systematic Transfer Plan
Systematic Withdrawal Plan

Systematic Investment Plan (SIP)

In SIP , a fixed amount is invest regularly every month on any scheme of investors
choice.The benefitof this kind of investing is that investors can take the advantage of the
market.This means if the market is bearish investors can accumulate more units and when
it is bullish investors accumulate less units.This is the benefit of disciplined investing.
Many a times it is seen that in bear markets, when the NAVs are at their rock bottom,
investor are gripped by panic and either stop their SIPs or worse, sell their units at a loss
which shouldnt be the case. In long run, disciplined approach brings down the average
cost price of the unit. Also this average cost price will be lower than the average sale
price per unit, irrespective whether the market is rising or falling.

Systematic Transfer Plan (STP)

In SIP investors money moves out of his savings account into the scheme of his choice.
In STP investors can invest in liquid funds initially such that on maturity this money is
invested on any scheme of investors choice.
Lets say an investor has decided to invest Rs 5,000 every month, such that Rs. 1,000 gets
invested on the 5th, 10th, 15th, 20th and 25th of the month. This means that the Rs. 5000,
which will get invested in stages till 25th and will remain in the savings account of the
investor for 25 days and earn interest @ 4%.

If the investor moves this amount of Rs. 5000 at the beginning of the month to a Liquid
Fund and transfers Rs. 1000 on the given dates to the scheme of his choice, then not only
will he get the benefit of SIP, but he will earn slightly higher interest as well in the Liquid
Funds as compared to a bank FD. As the money is being invested in a Liquid Fund, the
risk level associated is also minimal. Add to this the fact that liquid funds do not have any
entry/ exit loads. This is known as Systematic Transfer Plan.

Systematic Withdrawal Plan (SWP)

Here the investor invests lumpsum amount and then withdraws some money regularly
over a period of time. Because of this the principal amount invested comes down
Example an investor aged 60 years receives Rs. 20 lakh at retirement. If he wants to use
this money over a 20 year period, he can withdraw Rs. 20,00,000/ 20 = Rs. 1,00,000 per
annum. This translates into Rs. 8,333 per month. The investor will also get return on his
investment of Rs. 20 lakh, depending on where the money has been invested by the
mutual fund. Also if the effect of compounding is considered, he will be able to either
draw some more money every month, or he can get the same amount of Rs. 8,333 per
month for a longer period of time.

Chapter 4

SEBI has laid down regulations for the mutual fund industry.This is given as the SEBI

Many amendments have been made ever since its inception. The regulatory body has
taken many actions in the interest of the investor and one of them being ban on entry

4.1 Offer document

The Offer Document (OD) is a legal document and investors rely upon the information
provided in the OD for investing in the mutual fund scheme. The Compliance Officer in
an AMC has to sign the Due Diligence Certificate in the OD. This certificate says that all
the information provided inside the OD is true and correct. This ensures that there is
accountability and somebody is responsible for the OD. In case there is no compliance
officer, then senior executives like CEO, Chairman of the AMC has to sign the due
diligence certificate. The certificate ensures that the AMC takes responsibility of the OD
and its contents.
Every application form of the fund offer may or may not provide with a copy of offer
document (OD).But the Key Information Memorandum (KIM) has to be provided. Key
information memorandum is an abridged version of the offer document that provides
information of the key aspects of the scheme. The OD is split in two parts i.e Scheme
information document (SID) and Statement of additional information (SAI).
SID provides summary of the scheme, the risk involved and other such information. Also
statement of additional information (SAI) incorporates all statutory information on mutual
The SAI contains information about the sponsor, AMC and trustee companies. It provides
details of sponsors net worth, profit after taxes of 3years.It also provide the day when the
mutual fund was formed and the contribution made by the sponsor.
Also information regarding the trustees, the key personnel of the AMC and service
providers like custodian are given.

The other information present is rights of the unit holders of the scheme, investment
valuation norms and tax & legal information.
The SAI needs to upload in the respective mutual fund website and in the AMFI website.
Also SAI and SID are required to be updated within 3 months from the end of financial

4.2 Rights and obligation of the investors, trustees, AMC

Rights and obligation of investors

Investors are mutual, beneficial and proportional owners of the schemes assets. The
investments are held by the trust in fiduciary capacity (The fiduciary duty is a legal
relationship of confidence or trust between two or more parties).
In case of dividend declaration, investors have the right to receive the dividend within 30
days of declaration.
On redemption request by investors, the AMC must dispatch the redemption proceeds
within 10 working days of the request. In case the AMC fails to do so, it has to pay an
interest @ 15%. This rate may change from time to time subject to regulations.
In case the investor fails to claim the redemption proceeds immediately, then the
applicable NAV depends upon when the investor claims the redemption proceeds.
Investors can obtain relevant information from the trustees and inspect documents like
trust deed, investment management agreement, annual reports, offer documents, etc. They
must receive audited annual reports within 6 months from the financial year end.
Investors can wind up a scheme or even terminate the AMC if unitholders representing
75% of schemes assets pass a resolution to that respect.
Investors have a right to be informed about changes in the fundamental attributes of a
scheme. Fundamental attributes include type of scheme, investment objectives and
policies and terms of issue. Also investors are provided a 30 days window to exit the
scheme without any exit load.
Lastly, investors can approach the investor relations officer for grievance redressal. In
case the investor does not get appropriate solution, he can approach the investor grievance
cell of SEBI. The investor can also sue the trustees.

The offer document is a legal document and it is the investors obligation to read the OD
carefully before investing. The OD contains all the material information that the investor
would require to make an informed decision.
It contains the risk factors, dividend policy, investment objective, expenses expected to be
incurred by the proposed scheme, fund managers experience, historical performance of
other schemes of the fund and a lot of other vital information. It is not mandatory for the
fund house to distribute the OD with each application form but if the investor asks for it,
the fund house has to provide it to the investor. However, the Key Information
Memorandum (KIM) has to be provided with the application form.

Rights and obligation of trustees

The trustees and the AMC with the approval of SEBI enter into the investment
management agreement which contains necessary clauses for the purpose of investments.
Trustees are required to appoint auditors, compliance officer and registrars
The trustees shall ensure that all the activities of the asset management company are in
accordance with the provision of the regulation.
Each trustee shall file the details of his transactions of dealing in securities with the
mutual fund on a quarterly basis.
The trustee shall be accountable for the funds and property of the respective schemes and
shall hold the same in trust for the benefit of the unit holders.
The trustees shall obtain the consent of the unit holders,
-whenever required to do so by the Board in the interest of the unit holders.
-whenever required to do so on the requisition made by three-fourths of the unit holders
of any scheme; or
-when the majority of the trustees decide to wind up or prematurely redeem the units
The trustees shall quarterly review all transactions carried out between the mutual funds,
AMC and its associates.
The trustees shall quarterly review the net worth of the AMC and in case of any shortfall
ensure that AMC make up for the shortfall.
The trustees shall periodically review the investor complaints received and the redressal
of the same by the AMC
The trustees shall be discerning in the appointment of the directors on the board of the

The trustees shall obtain internal audit report at regular intervals from independent
auditors appointed by them.
The trustees shall obtain compliance certificates at regular intervals from the AMC
The trustees shall not be held liable for acts done in good faith if they have exercised
adequate due diligence honestly.

Asset Management Company and its obligation

The AMC shall take all reasonable steps and exercise due diligence to ensure that the
investment of funds pertaining to any scheme is not contrary to the provisions of the
regulations and the trust deed.
The AMC shall exercise due diligence and care in all its investment decisions and
whenever required shall obtain the approval from the recognised stock exchanges where
units are proposed to be listed.
The AMC shall submit to the trustees, quarterly reports of each year on its activities and
the compliance with these regulations.
The CEO (whatever his designation may be) of the AMC shall ensure that the mutual
fund complies with all the provisions of the regulations and the guidelines or circulars
issued in relation thereto from time to time.
The fund manager shall ensure that the funds of the schemes are invested to achieve the
objectives of the scheme and in the interest of the unit holders.
An AMC shall not purchase or sell securities through any broker which is average of 5%
or more of aggregate purchases and sale of securities made by the mutual fund in all its
In case any company has invested more than 5% of the net asset value of a scheme, the
investment made by that scheme or by any other scheme of the same mutual fund in that
company or its subsidiaries shall be brought to the notice of the trustees by the AMC and
be disclosed in the half yearly and annual accounts of the respective schemes with
justification for such investment.
Each director of the AMC shall file the details of his transactions of dealing in securities
with the trustees on a quarterly basis.
The AMC shall not appoint any person as key personnel who has been found guilty of
any economic offence or involved in violation of securities laws.

4.3 Rules regarding investments made by AMC

No scheme can invest more than 15% of its NAV in rated debt instruments of a single
issuer. This limit may be increased to 20% with prior approval of Trustees. This
restriction is not applicable to Government securities.
No scheme can invest more than 10% of its NAV in unrated paper of a single issuer and
total investment by any scheme in unrated papers cannot exceed 25% of NAV
No fund, under all its schemes can hold more than 10% of companys paid up capital.
No scheme can invest more than 10% of its NAV in a single company.
If a scheme invests in another scheme of the same or different AMC, no fees will be
charged. Aggregate inter scheme investment cannot exceed 5% of net asset value of the
mutual fund.
No scheme can invest in unlisted securities of its sponsor or its group entities.
Schemes can invest in unlisted securities issued by entities other than the sponsor or
sponsors group. Open ended schemes can invest maximum of 5% of net assets in such
securities whereas close ended schemes can invest upto 10% of net assets in such
Schemes cannot invest in listed entities belonging to the sponsor group beyond 25% of its
net assets.
It is mandatory for fund houses to have a minimum of 20 investors in a scheme with no
investor holding more than 25% of corpus.

4.4 Association of Mutual Funds in India(AMFI)

AMFI (Association of Mutual Funds in India) is the industry association for the mutual
fund industry in India which was incorporated in the year 1995.
The Principal objectives of AMFI are to:

Promote the interests of the mutual funds and unit holders and interact with regulators-
To set and maintain ethical, commercial and professional standards in the industry and to
recommend and promote best business practices and code of conduct to be followed by
members and others engaged in the activities of mutual fund and asset management.

To increase public awareness and understanding of the concept and working of mutual
funds in the country, to undertake investor awareness programmes and to disseminate
information on the mutual fund industry.
To develop a cadre of well-trained distributors and to implement a programme of training
and certification for all intermediaries and others engaged in the industry.

4.5 Compliance

To ensure the regulation laid down by SEBI is followed by all the fund houses, the
trustees are required to appoint a compliance officer. The compliance officer is
responsible for monitoring the compliances of the act, rules and regulations, notification,
guidelines, instruction etc. issued by SEBI or the Central Government and for redressal of
investor grievances. The compliance officer is an intermediary between the AMC and
SEBI.For each function like product design, investment, risk management, investor
grievances etc different committee are in place that function as per the prescribed rules.
Internal audits are carried out to check whether the policies are being followed. These
reports are reviewed by the compliance officer and any breach found is reported to the
board of directors and necessary action is taken.
Also whenever a new fund is approved by the board of directors and trustees, the
compliance officer looks in for the risk present and determines whether the draft of the
new fund offer will sail through the SEBI regulations or not.
On a day to day basis, they are required to monitor the investment restriction and
valuation of securities as they need to disclose the NAV on a daily basis.
Also they need to prepare month wise checklist to check whether the rules in each
committee are being followed.
A compliance test report including the general compliance, investment compliance and
investor service compliance has to be recorded and submitted by the AMC to the board
once in every 2 months. Also a monthly cumulative report needs to be submitted to the
board by 3rd of each month by email and hard copy.

4.6 Taxation

An important aspect of every investment is to know how the gains are going to be taxed
and what are the various taxes that are applicable.
Also debt schemes and equity schemes capital gains are taxed differently. It also differs
based on the kind of investor like the corporates, individual and NRIs
Given below is the tax applicable to individual investors.

Capital gain tax

Table 1: Capital gain tax

Equity schemes are those schemes that have 65% of average weekly net asset invested in
Indian equities. If the invested amount falls below 65% then its treated as debt scheme
and taxed accordingly.

In equity schemes there is no tax on capital gains if the investor remains invested for a
period of more than 12 months but he may have to bear other taxes like Securities
Transaction Tax @0.125%.Also if he exits the scheme before 12 months he will be taxed
at 15% on the gains he has made.

Whereas in debt scheme, if an investor remains invested for a period greater than 12
months, he is taxed on long term gains. The investor can choose how his gains should be
taxed with indexation or without indexation.

Indexation is provided to compensate for the inflation that eats up the returns.

Example: If an investor buys a unit at Rs. 10 and sells it at Rs. 30 after 5 years, then his
profit of Rs. 20 per unit needs to be adjusted for the inflation increase during the same
time period. This is because inflation reduces purchasing power. What Rs. 100 could have
bought when he bought the unit at Rs.10, would now have increased in price due to
inflation. Thus he can now buy less for the same Rs. 100. If during the same time,
inflation has increased by 12%, then the adjusted cost of the unit purchased (at todays
price) would be Rs. 10 * (1 + 12%) = Rs. 11.2. So his profit would not be Rs. 20, but Rs.
30 Rs. 11.2 = Rs. 18.8.
Now considering without indexation, he will have to pay 10% tax on Rs. 20 that comes
up to Rs. 2.If he opts for indexation he will have to pay 20% on Rs. 18.8 which comes up
to Rs.3.76.

Therefore by using both indexation and without indexation taxes can be calculated and
whichever makes the investor pay less tax he can opt for that option.

Other tax related information

Equity linked saving schemes provides income tax benefit upto Rs. 1lakh under section
80C of Income Tax Act.
There is no Dividend Distribution Tax(DDT) on equity schemes but for schemes other
than equity schemes they have DDT @12.5% which is taxed by the fund house itself.
There is no dividend tax to be paid out by the investors.

Chapter 5

Investor Awareness

5.1 Risk and Returns

Risk in simple terms means a possibility of suffering losses. Loss can be in terms of
variability of returns from an investment or the chance of non-payment of a debt and so
Every investment made is prone to different kinds of risk. Some of these risks are given

Inflation Risk
Inflation means rise in price of commodities like food, clothes, housing etc. Due to this
increase in price the investment made should be able to provide returns to compensate for
the rise in price without affecting the purchasing power of the consumer.

Opportunity Risk
It is a risk of tying up the money in some investment and losing the chance of putting into
something with real growth potential. In case a person invested in a FD offering a return
of 7% whereas another bank is offering 8% on FD, he has said to have lost an opportunity
of earning a little more on his investment.

Reinvestment Risk
It is the risk of not being able to invest the earnings, dividends or even the principal at the
same earning rate next month or next year. In case a person earned an interest of 8% in an
investment but due to fall in interest rate to 6% he wont be able to invest the earnings on
that investment for 8%

Interest Rate Risk

It is the risk of losing the opportunity to invest in a higher interest rate market if the
investment is tied up with a lesser interest rate instrument.

Credit Risk
It is the risk that the borrower would default in paying the interest or even the principal
Marketability Risk
It is the risk that there will be no ready market for selling the investment.

Currency Translation Risk

It is the risk that the value of the investment will change as the rupee rises or falls in
relative to other currencies.

Like risk, returns are also an important aspect of any investment. The returns earned
should not lower the persons ability to purchase goods. For example,if the inflation is at
9% and the investment made earns a return of 10% then the real returns earned is
1%.Also investments providing higher returns have higher risk too.
Different investment tool have different risk like saving bank, government securities carry
no real risk, equity shares of bluechip carry moderate risk whereas equity shares of new
companies have higher risk compared to others.

5.2 Know Your Customer

SEBI has mandated that all the investors investing in mutual funds need to comply by the
Know Your Customer norms. This is essential to guard against money laundering and
the need to know the source of the money that is being invested. Initially based on certain
limit of investment made by investors were asked to follow KYC norms but with effect
from 1st January, 2011 SEBI has made it compulsory for all investors irrespective of the
investments they make. Those investors who fail to complete the KYC norms, their
application wont be processed either for purchase or redemption.

Following documents and information needs to be provided by the investors, they are:
i. Proof of identity
ii. Proof of address
iii. PAN card
iv. Photograph

The originals of these documents along with a copy each to be presented and the original
will be returned after verification. Alternatively, investors can also provide an attested

true copy of the relevant documents. Attestation could be done by Notary Public/
Gazetted Officer/ Manager of a Scheduled Commercial Bank.
To avoid providing the same documents in all the mutual fund house a special
arrangement has been made with CDSL Venture Ltd.(CVL),a wholly owned subsidiary of
Central Depository Services (India )Ltd (CDSL). On behalf of all the mutual fund, they
would process and issue an acknowledgement. A copy of the acknowledgement needs to
be attached while making the investment for the first time. Also this facility is available to
investors for free of cost.
To assist the CVL in this process various companies are appointed as Point of Service
(POS) to accept and verify the documents. The list of POS is present in the AMFI
website. Also KYC application form can be downloaded from AMFI website, Mutual
fund website and CVL website.

5.3 Buying options available

New Fund Offer

One way of investing in mutual fund is during the fund offer. All that has to be done is to
fill in a form, make a cheque and deposit them both at a collection centre. An NFO is
open for 15 days and after the closing of the fund within 5 days either the units will be
allotted or money would be redeemed to the investors.

Mutual Funds
An investor can directly purchase units from the fund house. All one has to do is fill in the
application form, make a cheque of the amount to invest and receive an acknowledgement
from the mutual fund house. A fund house markets only its own scheme therefore
investors need to have full knowledge of what they are buying.

There are various intermediaries like banks, stockbrokers, certified financial planners and
independent financial advisors who advice about the various mutual fund schemes
available for investing.

Investors can directly log into the website of the fund house and make online choice of
schemes and payment. Also there are financial portals like myiris.com and online trading
portals like ICICIDirect and Sharekhan offer a number of mutual fund schemes.

Stock Exchange
Close ended schemes and ETF are traded on stock exchange. To improve penetration of
mutual fund due to falling interest of distributors owing to low commission, stock
exchange as means to reach investors is gaining momentum. Presently mutual fund is
present only in Tier 1 cities and has low presence in Tier 2 and Tier 3 cities. Therefore
stock exchange now provides a platform to offers mutual fund schemes for investors
where they could purchase as well as sell their units.

5.4 Following on Investments

The mutual funds are required to publish the Net Asset Value of close ended schemes on
a daily basis in at least 2 daily newspaper having circulation all over India. In case of
open ended schemes they need to publish the sale and repurchase price of the units at
least once a week in a daily newspaper of all India circulation. Also the mutual fund
should not lower the repurchase price of the units below 93% of NAV and sale price
should not be higher than 107% of the NAV. Also the repurchase price of the units of
close ended schemes should not be lower than 95% of the NAV. Other than NAV of a
scheme, ET-Wealth is a newspaper issued once a week that provide information and
ratings of different mutual fund schemes.

The NAV of the units are to be updated on AMFI website (www.amfiindia.com) every
day before 9 a.m The NAV can be ascertained from the website of the respective fund
houses also. The other websites providing this information are www.moneycontrol.com,
www. valueresearch.com and www.mutualfundsindia.com.

There are numerous magazines that write articles on the performance of mutual fund
schemes. Value Research is a credit rating agency that rates the mutual fund schemes.
Also they have a monthly issue of their magazine Mutual fund insight that provides
opinion, suggestion and rating of the schemes.
The other ways an investor can track his investment performance is by the information
provided by the fund house in annual report, half yearly report and fund fact sheet which
is provided on monthly basis.

5.5 Complaints and queries

All investor grievances are handled by the investor relation officer of the respective
AMC. In case the investor is not happy with the handling of his case he can approach
SEBI who will look into the matter. Also as per regulations, all the AMCs are required to
disclose the investor complaints in their annual report, upload it in their website and in the
AMFI website. The details furnished needs to be signed by the trustees of the respective
If there is any issue between the broker and the investor investing through stock exchange
he can address the same on investor grievance section of the respective stock exchange

5.6 Investor Behaviour

Standard finance assumes that people act in rational way to achieve what is in their own
best interest. The idea of rationality assumes that we all know a great deal more about
finance than we really do. It also assumes that we ignore issues of fairness and many
other emotions that motivate most people. But in reality, this isnt true. Behavioural
finance is a growing study of subject that looks into human behaviour and their way of
reacting to different financial situation. It majorly studies the irrational way investors
view risk. Dr. Amos Tversky and Dr. Daniel Kahneman are pioneers in the field of
behavioural finance and they had come up with a theory called Prospect theory.
According to the researchers the investors feel much more pain when they lose $1 than
they feel pleasure when they gain $1.In case he was a rational person he would have

assumed to view the gain and loss of $1 equally. But they observed that an investor is
willing to take more risk to avoid a loss than he will take to achieve a gain.
Some of the behavioural traits that an investor exhibits are given below:

Loss Aversion- Investors are ready to take higher risk when making a loss than they
would take to make a profit.

Endowment effect-Investors are resistant to change even when they know some of their
investments are not doing well. They suffer from decision paralysis as they cant decide
to part with them.

Recency effect-Investors tend to give greater importance to events or developments that

have occurred recently than those taken place in distant past. This makes people to buy in
a rising market and sell in a falling market.

5.7 Recent changes in Mutual fund industry

Ban on entry load and limit on exit load

SEBI has introduced a ban on the entry load charged by the mutual fund house with effect
from 1st August 2009.Also the exit load charge should not exceed 1%.

Compulsory certification for mutual fund distributors

Also AMFI has made it compulsory for distributors to take NSE certification for
distribution of mutual fund schemes. Any person without this certification will not be
required to be paid upfront commission by investors.

Know Your Customers (KYC) norms

KYC norms are applicable to all investors. This requires obtaining and maintaining the
particulars of the investors of mutual funds in accordance with KYC norms issued by
SEBI including proof of their address and proof of their identity. This is essential to guard
against money laundering and the need to know the source of the money that is being

Know Your Distributors(KYD) norms
KYD requirements have been introduced by AMFI under SEBI diktat. It is mandatory to
comply with the KYD procedure with effect from 1st September 2010 before applying for
fresh AMFI registration number (ARN) or renewal of ARN. Existing ARN holder are
required to comply with KYD norms by the end of Feb 2011,failing which payment of
commission will be suspended till ARN holders comply with KYD norms. Distributors
are required to visit the nearest point of service with duly completed KYD application,
photocopies of relevant documents and self -attested photos. They are also required to go
through a biometric verification.

Cap on the investment by banks on liquid funds

RBI has capped the banks investment in mutual fund liquid schemes to 10% of their net
worth. Banks have been one of the major investors in the liquid schemes offered by the
fund houses. Around 80% of money invested by banks in mutual fund is in liquid
schemes. And that was around Rs.1.11 lakh crore as on 6th April 2011.The total net worth
of banking system is estimated to be around Rs. 3.13 lakh crore. As per the experts, an
outflow of Rs.60,000 crore is expected by November 2011.

Online option available to investors

To lure more investors and to gain a competitive advantage, many fund houses provide
online option for subscribing to their schemes. This process requires the paperwork to be
done only once, there after all the transaction that is carried is paperless. This helps save
investors money which is paid as commission to the distributors. Also the website
provides tools to investors to make as well as track their investments.

Disclosure of investor complaints in the annual report

In order to improve the transparency in the grievance redressal mechanism, SEBI has
recently issued a circular that requires mutual funds to include details of investor
complaints in their Annual Report, beginning with the annual report for the year 2009-10.

Change in Interval Schemes

As per SEBI regulations the units of interval schemes shall be mandatorily listed.No
redemption/repurchase of units shall be allowed except during the specified transaction
period (the period during which both subscription and redemption may be made to and

from the scheme). The specified transaction period shall be of minimum 2 working days.
Minimum duration of an interval period in an interval scheme/plan shall be 15 days.
Investments shall be permitted only in such securities which mature on or before the
opening of the immediately following specified transaction period.

Some more plans for mutual funds:-

Open ended scheme to have de-mat account

SEBI is in plans to provide investors with the option to hold their units of open ended
schemes in dematerialized form. Currently, only units of close ended schemes are given
the option of holding the units in physical or de-mat form.

Mutual funds (MFs) to open doors to foreign investors

Currently, apart from resident investors, only Foreign Institutional Investors and sub-
accounts registered with the SEBI and NRIs are allowed to invest in mutual fund
schemes. Budget 2011 proposes to permit SEBI registered MFs to accept subscriptions
from foreign investors (foreign individuals) who meet the KYC requirements for equity
schemes. This move is meant to enable Indian MFs direct access to foreign investors and
widen the class of foreign investors in Indian equity market. However, the exact form and
shape of this proposal is yet to be announced. All in all, this will be a significant positive
for not only mutual funds in particular but the capital market in general

Chapter 6

Findings and Conclusion

After going through a detailed study on mutual funds in India, we can see a great
opportunity for the mutual funds as there lay an untapped population who can be the
future investors. Also the growing cost of living requires people to opt for other means of
investment than the traditional ones like PPF and FDs.

It has been seen that the corporates are the major investors in mutual funds than retailers.
On 31st Mar, 2010 around 51% contribution came from corporates but only 26%
contribution was made by retailers, but on 31st Mar, 2011 the contribution of corporates
fell down to 44% and the retailers contribution increased to 27%.Therefore, this increase
in contribution by retailers although minimal is important as there is a huge unorganized
retail industry in India who can make most use of this investment tool. Also the
household investment in mutual fund is minimal. This is due to financial illiteracy.

More than financial illiteracy, the complexity of subject makes mutual fund less attractive
to investors. If this complexity is reduced like finding a simpler word for a technical word
then we can have many takers for it.

Also too many schemes of similar nature handicaps the investors choice as there is too
much for him to choose from. This leads to more confusion than any help to him.

Increase in investor awareness has been a good initiative taken up by AMFI which
provides a platform for AMCs to conduct Investor Awareness Program in different
cities. Till date more than 2000 programs has been conducted covering more than 60,000
participants. Similarly, such programs on investor awareness are also carried out by stock
exchanges like BSE and NSE.

Therefore we can conclude that giving investors the knowledge of this industry by
simplifying the concept and making them understand the need of investment will help
them make wise investment decision than avoiding a good opportunity.

Chapter 7

These are some of the recommendation for the mutual fund industry and the investors.

Financial literacy is important and therefore spreading this knowledge to youth can help
them make good investment decision when they start earning. There is a need for the
investor awareness program conducted in colleges as they are the next potential investors.
This can be seen as an investment of knowledge in present whose benefit can be reaped in

Knowledge of mutual funds as an investment tool is one part but being aware of our own
mistakes is another. Therefore, investor behaviour needs to be included in investor
awareness program so that the investors are aware of the common mistakes they make.

Many a time investors may find it difficult to pick a scheme that matches their need or
goal. Therefore, offering customers products specific to their goal can help them.

Like we need a Chartered Accountant who does our tax planning, similarly we may need
a Financial Planner who can help us plan our financial goals and help reach them. They
have a profound knowledge on this field which can be of great use to investors.