IP and Asset Management- India Specific - Additions to Chapter-1 - 7

Chapter-1: Additions Primary Market The primary market is a place for the new companies to raise capital from investors. Even existing companies can tap the stock markets with rights to their shareholders or follow-on offers to even new investors. Once these new securities are listed for trading, the trading happens as part of the secondary market along with other listed securities. Thus, in the primary market, the government or corporate sector issues securities that change hands from the issuer to investors (new owners) who become shareholders. Borrowers exchange new financial securities for long-term funds. Thus, primary market facilitates capital formation. The primary market is where securities are created. It is in this market that firms sell (float) new stocks and bonds to the public for the first time. An initial public offering, or IPO, is an example of a primary market. Functions of Primary Market • Offer of New Issue Offers of New Issue are organised in the primary market. These shares offered to public had not been traded on any other exchange earlier. Organizing new issue offers involves a detailed assessment of project viability, among other factors. The financial arrangements for the purpose include considerations of promoters’ equity, liquidity ratio, debt-equity ratio, and requirement of foreign exchange. • Underwriting Services Underwriting is a contract using which a person gives an assurance to the issuer to the effect that the former would subscribe to the securities offered in the event of non-subscription. The underwriters do not buy and sell securities. Underwriting is an essential aspect while offering a new issue. An underwriter’s role in a primary marketplace includes purchasing unsold shares if it cannot manage to sell the required number of shares to the public. A financial institution may act as an underwriter, earning a commission on underwriting. IP and Asset Management – India Specific Page 1

• Distribution of a New Issue A new issue is also distributed in a primary market. Such distribution is initiated with a new prospectus issue. It invites the public at large to buy a new issue and provides detailed information on the company, issue, and involved underwriters Origination The term origination refers to the work of investigation and analysis and processing of new proposals. Specialist agencies perform these functions which act as sponsors of the issue. This is to ensure that it warrants the backing of the issue houses in the sense of lending their name to the company, thus giving the issue the stamp of respectability. It shows that the company is strong, has good market prospects, and is worthy of stock exchange quotation. Intermediaries in Primary Market Investment Banks: Investment Banks play the role of a financial advisor in assessing the market demand of a company’s issue, and in making all preliminary arrangements for the sale of shares through initial public offering (IPO). They ensure all regulatory formalities are satisfied, estimate the demand for the issue and fix the share offer price, and undertake to sell all the shares offered through the IPO. If the issue is unsuccessful and the shares are not fully subscribed for, the remaining shares are bought by the Investment Bank, thus performing the role of underwriter in a sort of insurance to protect the issuer from under subscription. In a larger role, investment banks play a vital role in the smooth functioning of financial markets across countries and geographies. They help raise capital for a country’s economy apart from helping wealthy investors such as corporations, governments, and high- net-worth individuals generate good ROI (Return on Investment) on their hefty monetary investments in the financial markets. They facilitate mergers and acquisitions for businesses which involves studying of balance sheets of companies, performing financial modelling, and identifying the risk involved. Investment banks help companies make investment decisions based on reports submitted by them to potential investors. Research reports provide for a good understanding of the worthiness of a company that is listed on the trade or stock exchange. IP and Asset Management – India Specific Page 2

Lead Managers: Lead Managers play a crucial role in the issue process. They design and finalise the offer document, prospectus, advertising and fulfil all formalities required by the regulator, registrar of companies, stock exchanges, etc. They are also called Book Running Lead Managers. Depending on the size of the IPO, more than one lead manager may be appointed. Registrars Registrars specialise in processing the bids of investors in the IPO, as per the guidelines and regulations of SEBI, process applications, collect funds from investors whose bids are accepted and shares have been allotted and make refunds to the bank accounts of the investors who are not allotted any shares or made partial allotment. They constantly coordinate with the appointed banks and lead managers and apprise the latter on the application demand, subscription amount collected and other information to assess the demand, progress and success of the issue Types of Issues – Public and Preferential The following is a map of several possible types of issues in the primary markets. Public Issue through the Prospectus The Public Issue with prospectus is the most popular method of raising funds by public limited companies. The most common method of raising capital for new companies is through an IPO (Initial Public Offer). It is the first public issue of the shares of a private company that is going public. Follow-on Public Offer (FPO). It is the second or subsequent public issue of the shares of an already listed public company. It is offered with an aim to garner subsequent public investment. Preferential Issue Preferential Issue is the fastest way for a company to raise capital. A preferential issue is an issue of shares or convertible securities by listed or unlisted companies to a select group of investors, but it is neither a rights issue nor a public issue. A person holding preferential shares has the right to be paid IP and Asset Management – India Specific Page 3

from company assets before common stockholders if the company goes into bankruptcy. They usually do not have voting rights and are rewarded only by dividends. Rights Issue Rights issues are defined as the method of raising funds in the market by an existing company. A right means an option to buy certain securities at a certain privileged price within a certain specified period. Shares so offered to the existing shareholders are called rights shares. The rights ratio determines the quantity of new shares in relation to the existing held shares. Such rights shares offered to the existing share ownership are transferable and saleable in the market. The existing shareholders vested with rights shares or the fresh acquirers of such shares have to shell out a pre-determined price of rights shares as per a formula which takes into account the security’s prices over some prior period. The Rights share price so determined offers some benefit over the ruling market price for the Rights offer to retain the issue’s attractiveness. Bonus Issue Bonus shares are shares given to the existing shareholders free of cost in proportion to the number of shares they hold. They are additional shares given to the current shareholders. It is further issue of shares by a company to its existing shareholders without any consideration. For Example, if the investor holds 100 shares of a company and a company declares a 2:1 bonus offer; his holding of shares will be additional 200 shares therefore making now 300 shares instead of 100 original shares. Types of Placement – Equity and Debt Private Placement of Shares Private placement of shares is the issuance of securities of a Company to a selected individual, group of individuals, corporate, or group of corporate. The securities during this placement are not publicly offered. A private placement is also made by bargaining with financial institutions for the share of the contribution offered. Private placements have several advantages: • Cost-effective method of raising funds • Time efficient as the requirements to be fulfilled is less, about 2 to 3 months • Structured effectively to meet the needs of entrepreneurs as well as the financial intermediaries who are buying it. IP and Asset Management – India Specific Page 4

Qualified Institutional Placements (QIPs) Qualified institutional placements (QIPS) are a way to issue shares to the public without going through standard regulatory compliance. QIPs instead follow a lighter set of regulations but where allottees are more highly regulated. The practice is mostly used in India and other Southeast Asian countries. QIPs were created to avoid dependency on foreign resources for raising capital. Qualified institutional buyers (QIBs) are the only entities allowed to purchase QIPs. The following is a comparison of Initial Public Offer (IPO), Follow-on Public Offer (FPO), Offer for Sale (OFS) and Right Issue (RI): Public Issue of Debt Securities The debt market is an avenue for Indian Corporates where they can do a public issue of debt securities which include the issuance of Non-Convertible Bonds / Debentures. These may be issued by Corporates, Financial Institution, and Public Sector Unit. SEBI regulations prescribe that all public issues of Debt Securities are required to be listed on one or more recognized Stock Exchanges. SEBI (Issue and Listing of Debt Securities) Regulations, 2008 and amendments thereon govern the public issue of debt securities Modes of Public Issue of Debt Securities: • Self – Certified Syndicate Banks • Intermediaries (RTA’s, Depositories etc.) • Stock Exchange (App, Web interface or UPI IP and Asset Management – India Specific Page 5

Pricing of a Public Issues of shares A Fixed Price Issue is an Initial Public Offering (IPO) where the issuer at the outset decides the issue price mentions it in the offer document. The price band within which the securities are offered and would be allotted is made known in advance to the investors. Demand for the securities offered is known only after the closure of the issue and 50% of the shares offered are reserved for applications below Rs. 2 lakh and the balance for higher amount applications. In a Book Built Issue, the price of an issue is discovered based on-demand received from the prospective investors at various price levels. The price at which securities will be offered/allotted is not known in advance to the investor. Only an indicative price range is known. Demand for the securities offered can be known every day as the book is built and payment is received only after the allocation made Regulatory Norms for Public Issue of Shares SEBI is responsible for the entry norms of a Public Issue, which it does through SEBI (Disclosure for Investor and Protection) Guidelines, 2000. SEBI must amend these norms to suffice the present requirement of time by upholding the principles of transparency and investors' protection for the development of the capital market. For a better understanding of the regulatory norms, the following categorization is done: Unlisted Companies (IPO) • At least Rs 3 crores of net tangible assets should be present in all the preceding 3 years individually, out of which monetary assets should amount to not more than fifty per cent. • There should be a record which shows that out of immediately 5 years at least 3 of them have profit which can be distributed. • In all the previous 3 years there should be a pre-issue net worth of at least Rs 1 crore. • The company should keep its issue size not more than 5 times its pre-issue net worth. An unlisted Company not complying with any of the conditions specified above may make an initial public offer if it meets both the following conditions: • The book-building process should be utilized while issuing shares and at least fifty per cent should be allotted to Qualified Institutional buyers, failing which the full subscription shall be refunded. [OR] IP and Asset Management – India Specific Page 6

• The Financial Institutions' participation of at least fifteen presents should be present in a project out of which at least 10% comes from an appraiser. Also, QIBs should be allotted at least 10% of the issue size, failing to comply will result in refunding the full subscription monies. [AND] • Rs. 10 crores should be the minimum face value capital of the Company after issue. [OR] • A compulsory market-making for at least 2 years Listed Companies (FPO & Offer for Sale) - Before making a further public offer/Offer for Sale, the issuer shall file three copies of the draft offer document with the concerned regional office of SEBI under the jurisdiction of which the registered office of the issuer company is located, by Schedule IV, along with fees as specified in Schedule III, through the lead manager(s). Offer for Sale - After the consulting board of directors, some members can offer whole or a part of their shareholdings to the public. The offer document for this purpose should comply with the prospectus requirements as this document is deemed to be a prospectus. Any expenditure incurred will be reimbursed to the company by the member. Further, the dividends incurred on these offered shares shall be payable to the transferees. Process of Applying to a Public Issue (IPO) Once your Demat-cum-trading account is activated, you can apply for IPO in two ways, either online or offline. Offline Application - A customer can make offline application by visiting the branch of his/her brokerage firm. Online Application - It can be done via the website or mobile application of the Customer’s bank. It must be noted that you need ASBA (Application Supported by the Blocked Amount) which is mandatory along with the KYC details. ASBA is a process that eliminates the need for a draft or cheque and authorizes a customer’s bank to block his/her funds for the bidding process. Secondary Market In the functioning of the modern economic landscape, Exchanges play a vital role. After the issuing of securities such as shares and bonds in the primary market, exchange being the secondary market is where the subsequent action happens. Also called a ‘bourse’, a stock exchange is a platform for trading in securities. As they are a common platform that attracts a large number of individual or institutional IP and Asset Management – India Specific Page 7

traders, the risk of finding a buyer or seller is eliminated. Issuers must list the securities on the exchanges and constantly comply with the regulations and guidelines of the exchanges and the regulator. Besides equity shares, bonds, and other securities, exchanges also facilitate trading in commodities, currencies and derivatives. Functions of Secondary Market Protects Investors As companies are listed after due diligence and the activities of the stock exchange are controlled, the funds of the investors are very much protected. Facilitates Borrowing (Pubic) The stock exchanges serve as a platform for marketing Government securities. It enables the government to raise public debt easily and quickly. Similarly private sector companies can raise resources by offering equity to the public. Healthy Speculation Healthy speculation keeps the exchange active. Normal speculation is not dangerous but provides more business to the exchange. However, excessive speculation is undesirable as it is dangerousto investors and the growth of the corporate sector. Exchanges provide a well-monitored and regulated speculation by way of derivative instruments (futures and options). Facilitates Liquidity Companies and institutions like banks can invest their idle funds in the short-term securities and earn profit. It facilitates trading in such securities and hence liquidity. The same virtue of trading volumes and liquidity in stocks ensures equilibrium in prices and thus confidence in traders and investors. IP and Asset Management – India Specific Page 8

Evaluation of Securities The stock exchange is useful for the evaluation of industrial securities. This enables investors to know the true worth of their holdings at any time. Comparison of companies in the same industry is possible through stock exchange quotations. (i.e., price list). The quoted price of a Company’s stock helps determines its true marketable value for merger and takeover. Encourages Capital Formation The stock exchange plays an active role in the capital formation in the country. Companies can raise funds either by issuing more shares through rights shares or bonus shares. In addition, it acts as a channel for wealth creation over longer periods by investing in the performing and upcoming sectors of the economy. Serves as an Economic Barometer The stock exchange indicates the state of health of the whole variety of companies and financial institutions and thus to some extent the trend in the health of an economy. A politically and economically strong government will have an upward trend in the stock market, whereas an unstable government with heavy borrowings from the public and from the lending institutions abroad will have a downward trend in the stock market. It acts as a barometer of the economic situation as well as changing conditions. Mobilizes Savings The savings of the public are mobilized through mutual funds, investment trusts and by various other securities. Even those who cannot afford to invest in huge lump sum amount in the securities are provided opportunities of systematic small investments through mutual funds and investment trusts route. Exchange Infrastructure Clearing and Settlement The transactions in secondary market pass through three distinct phases, viz., trading, clearing and settlement. While the stock exchanges provide the platform for trading, the clearing corporation determines the funds and securities obligations of the trading members and ensures that the trade is IP and Asset Management – India Specific Page 9

settled through exchange of obligations. The clearing banks and the depositories provide the necessary interface between the custodians/clearing members for settlement of funds and securities obligations of trading members. Several entities, like the clearing corporation, clearing members, custodians, clearing banks, depositories are involved in the process of Clearing. Clearing Corporation: The clearing corporation is responsible for post-trade activities such as risk management and clearing and settlement of trades executed on a stock exchange. The first clearing corporation to be established in the country and also the first clearing corporation in the country to introduce settlement guarantee is the National Securities Clearing Corporation Ltd. (NSCCL), a wholly owned subsidiary of NSE. NSCCL was incorporated in August 1995. The Indian Clearing Corporation Limited was established by BSE in 2007 and it is a wholly owned subsidiary of BSE. Its main functions are clearing and settlement, collateral management and risk management. The main objectives of clearing corporation are: to bring and sustain confidence in clearing and settlement of securities, to maintain short and consistent settlement cycle, to provide counterparty risk guarantee, and to operate a tight risk containment system. Clearing Members are responsible for settling their obligations as determined by the clearing corporation. They do so by making available funds and/or securities in the designated accounts with clearing bank/ depositories on the date of settlement. Clearing banks are a key link between the clearing members and Clearing Corporation to effect settlement of funds. Every clearing member is required to open a dedicated clearing account with one of the designated clearing banks. Based on the clearing member’s obligation as determined through clearing, the clearing member makes funds available in the clearing account for the payin and receives funds in case of a pay-out. Custodians Custodians are clearing members but not trading members. They are financial institutions (in India, they include Axis Bank Ltd, BNP Paribas Ltd, Edelweiss Custodial services Ltd, HDFC Bank Ltd, ICICI Bank Ltd, Kotak Mahindra Bank Ltd, SBI, etc.) that holds customers' securities for safekeeping to prevent them from being stolen or lost. The custodian may hold stocks or other assets in electronic or physical form. Most custodians offer related services such as account administration, transaction settlements, collection of dividends and interest payments, tax support, and foreign exchange management. The fees charged by custodians vary depending on the services that the client needs. IP and Asset Management – India Specific Page 10

Many firms charge quarterly custody fees based on the aggregate value of the holdings. Investment advisory firms routinely use custodians to safeguard the assets they manage for their clients. They settle trades on behalf of trading members, when a particular trade is assigned to them for settlement. The custodian is required to confirm whether he is going to settle that trade or not. If it confirms to settle that trade, then clearing corporation assigns that particular obligation to him. Depository and Depository Participants: Depository holds securities in dematerialized form for the investors in their beneficiary accounts. Each clearing member is required to maintain a clearing pool account with the depositories. Clearing member is required to make available the required securities in the designated account on settlement day. The depository runs an electronic file to transfer the securities from accounts of the custodians/clearing member to that of NSCCL and visa-versa as per the schedule of allocation of securities. The two depositories in India are the National Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL). A depository participant is registered with SEBI and acts as a link between issuers of securities and the depository. They register and open accounts not only for trading in securities through exchanges but also holdthose securities in the demat (dematerialisation) accounts. Brokers, banks and other financial institutions which are brokers that facilitate trading in securities thus, also act as DP. Stockbrokers and Authorized Persons: Brokers are intermediaries who have the authorization and expertise to buy securities on an investor's behalf. The investments that brokers offer include securities, stocks, mutual funds, exchange-traded funds (ETFs), and even real estate. Many brokers can also offer advice on which stocks, mutual funds, and other securities to buy. Although there are various types of brokers, they can be broken down into two categories – Full-service brokers and Discount brokers. The former category can advise clients and can offer discretionary management of funds. The discount brokers can only execute buy and sell transactions on behalf of their clients. IP and Asset Management – India Specific Page 11

Traders: A stock trader is a professional who trades on behalf of its clients by holding their trading accounts linked with secured and authenticated bank accounts. Traders can also be investors in their proprietary trades. They are an integral part in connecting investors to the markets by providing platforms of trading and settlement, keeping up-to-date balances in the respective DP accounts and providing other support services such as research. Depending on the style of trading activity, the market participants also come to be categorized as investors or traders. Some of these categories are described below: • Swing Traders They use a slightly longer time horizon than day traders, watching a stock for weeks or months before trading. They try to follow the momentum of the stock market when buying stocks. When markets are, in general, moving up, traders will buy stocks that fit whatever criterion they are using to select stocks, and will sell when this swing in the market has topped or nearing what they have calculated to be the top. • Intra-day Traders Traders in this capacity are generally classified as speculators. Day trading contrasts with the long-term trades underlying buy and hold and value investing strategies. Day traders and intra-day traders are at the top of the risk spectrum. They participate in rapidly changing market conditions, looking for quickly developing profit opportunities. Mostly these traders employ technical analysis to determine when conditions are right to enter either long or short, and then to exit. IP and Asset Management – India Specific Page 12

• Futures and Options Traders They do not invest in the underlying asset to profit from price fluctuations, but in the derivatives which are based on the future price trends of those underlying assets. Traderswho trade in this capacity are generally classified as speculators. The four types of futures traders in the futures trading market are Hedgers, Speculators, Arbitrageurs, and Spreaders. Options traders tend to make their profits through the buying, selling, and writing of options rather than ever actually exercising them. Options traders can make profits through buying options contracts and selling them at a higher price. Also, in the same way that stock traders can take a short stock position that they believe will go down in value options traders can do the same with options contracts. • Commodity Traders Commodity traders are individuals or businesses which buy and sell physical commodities such as metals or oil. Traders in this area aim to profit off anticipated trends as well as arbitrage opportunities. Their day-to-day buying and selling are often driven by expected economic trends or arbitrage opportunities in the commodities markets. Commodity markets typically trade in the primary economic sector, including industries focused on collecting natural resources for profit. Credit Rating Agencies: A credit rating agency is a company that assigns credit ratings, which indicate a debtor's ability to pay back timely the principal and interest thereon and the likelihood of default, if any. They provide superior information to the investors by assessing the credit risk in the investments. They collect,analyze, interpret, and transforms data into a very lucid and easily understandable language. Ratings are denoted by a simple alphanumeric symbol, for e.g., AA+, A- etc. Some of the top credit rating agencies in India are as follows: • CRISIL (Credit Rating and Information Services of India Limited): One of the oldest rating agencies to have launched India’s first index to benchmark performance of investments of foreign portfolio in the fixed-income market. • ICRA (Investment Information and Credit Rating Agency): A public limited company was a joint venture between Moody’s and several Indian financial and banking service organizations. At present, Moody’s Investors Service, the international Credit Rating Agency, is ICRA’s largest shareholder. IP and Asset Management – India Specific Page 13

• BWR (Brickwork Ratings): BWR is promoted by Canara Bank and offers ratings for bank loans, SMEs, corporate governance rating, Municipal Corporation, capital market instrument, and financial institutions. • Infomerics Valuation and Rating Private (IVRP) Limited: An RBI-accredited and SEBIregistered credit agency, Infomerics Valuation and Rating Private Limited saw its inception by eminent finance professionals to offer an unbiased and detailed analysis and evaluation of creditworthiness to NBFCs, banks, corporates, and small and medium scale units Keeping transparency as it is a core value and accurate reports and records of all their clients. • CARE (Credit Analysis and Research limited): CARE offers credit rating services to areas such as corporate governance, debt ratings, financial sector, bank loan ratings, issuer ratings, recovery ratings, and infrastructure ratings. They also offer ratings for Initial Public Offerings (IPOs), real estate, renewable energy service companies, and various courses of educational institutions. Credit Bureaus: While Indian credit rating agencies (CRAs) evaluate the safety or risk of investment options offered by companies or institutions, credit information companies in India, commonly referred to as credit information bureaus (CIBs), generate credit scores and reports related to borrowers in the country Credit Bureaus came into existence in the late 1980s and have ever since been instrumental in determining the nature and integrals involved in a loan. Each credit bureau vies to make life simpler for individual consumers and companies by providing a detailed analysis of their credit history. A credit rating agency or CRA is an organization that evaluates the creditworthiness of an individual along with their ability to pay back the loan amount and other debts. These credit bureaus provide a credit score of individuals that help banks determine whether an individual is worthy of taking a loan based on his or her financial history. There are five main Credit Bureaus in India registered under SEBI, namely: • TransUnion Credit Information Bureau (India) Limited (or CIBIL) • Credit Rating Information Services of India Limited (CRISIL) • Equifax • ICRA (formerly known as Investment Information and Credit Rating Agency of India Limited) • CRIF High Mark IP and Asset Management – India Specific Page 14

Registrar and Transfer Agents: Registrar and transfer agents are the trusts or institutions that register and maintain detailed records of the transactions of investors for the convenience of mutual fund houses. Their role also extends to providing information to the investors about new offers, maturity dates of all other investor-friendly information at one place for their reference. Some of the RTAs operating in India are Computer Age Management Services (CAMS), Karvy, and Deutsche Investor Services, among others. KRA (KYC Registration Agencies): The KYC process across different SEBI registered intermediaries like venture capital funds, portfolio managers, Mutual Funds, etc. was not uniform at all. As per the SEBI guidelines of 2011, the investors who wish to invest in Mutual Funds or become KYC complaints must register with any one of the above-mentioned agencies. Once the customers are registered or are KYCcompliant, they can start investing in Mutual Funds. The records of the completed KYC process are stored centrally by the agency and can be accessed by other intermediaries and KYC registration agencies. Any changes that may occur in the future are updated centrally. This can be done by giving a single request to the agency through any registered intermediary. IP and Asset Management – India Specific Page 15

Major Stock Exchanges – Stock Indices – Basis and Composition In India, the National Stock Exchange and the Bombay Stock Exchange are two major exchanges. Let us learn about the two. Bombay Stock Exchange Established in 1875, BSE (formerly known as Bombay Stock Exchange Ltd.), is Asia's first & the Fastest Stock Exchange in world with the speed of 6 microseconds and one of India's leading exchange groups. Over the past 143 years, BSE has facilitated the growth of the Indian corporate sector by providing it an efficient capital-raising platform. Popularly known as BSE, the bourse was established as ‘The Native Share & Stockbrokers’ Association’ in 1875. In 2017 BSE become the 1st listed stock exchange of India. BSE's popular equity index - the S&P BSE SENSEX - is India's most widely tracked stock market benchmark index. It is traded internationally on the EUREX as well as leading exchanges of the BRCS nations (Brazil, Russia, China and South Africa)9 On February 19, 2013, S&P Dow Jones Indices and the BSE Ltd. (formerly Bombay Stock Exchange (“BSE”) announced their strategic partnership to calculate, disseminate, and license the widely followed BSE suite of indices. The S&P BSE family of indices measures the performance of BSE listed companies across various sizes, industries, themes, and strategies. Each index is designed to represent a certain segment of the Indian equities market. The Broadbased indices act as market indicators for the Indian stock market, covering large-cap, mid-cap, and small-cap companies. The most popular benchmark, also the oldest in India, is the S&P BSE SENSEX, comprising of 30 large, well-established and financially sound companies across key sectors. Other indices from the BSE stable are S&P BSE 100 (comprising 100 largest and most liquid Indian companies, basically Large Mid Cap), S&P BSE SENSEX 50 (comprising of 50 largest and most liquid companies), etc. S&P BSE 500 index is designed to be a broad representation of the Indian capital market. Thematic indices include S&P BSE PSU, S&P BSE CPSE, and S&P BSE Bharat 22 Index. Strategy indices include S&P BSE IPO, S&P BSE SME IPO, S&P BSE DOLLEX Indices, S&P BSE SENSEX Futures Index, S&P BSE Arbitrage Rate Index, S&P BSE SENSEX 2X Leverage Daily Index and S&P BSE SENSEX Inverse Daily IP and Asset Management – India Specific Page 16

Indices. The Sector indices are equity benchmarks for BSE traded securities in several broadly defined economic sectors. The indices include companies in the S&P BSE 500 that represent nine sectors of the economy and contain a minimum of 10 companies per index. Sector indices include S&P BSE Auto, S&P BSE Capital Goods, S&P BSE Oil & Gas, S&P BSE Consumer Durables, S&P BSE Metal, S&P BSE Realty, S&P BSE Bankex, S&P BSE Tech, and S&P BSE Power. Realized Volatility indices S&P BSE REALVOL- 1MTH, S&P BSE REALVOL-3MTH, S&P BSE REALVOL 2MTH measure the historic volatility of the S&P BSE SENSEX over fixed 1, 2, and 3-month time horizons, which are synchronized with BSE’s 1, 2, and 3 month futures and options expiration cycles. Index Methodology Most of the indices employ a float-adjusted market capitalization-weighting scheme, using the divisor methodology used in S&P Dow Jones Indices’ equity indices. S&P BSE SENSEX is derived from the constituents of the S&P BSE 100. The inclusion of DVRs in the index will result in more than 30 stocks in the index. However, the number of companies in the index remains fixed at 30. Stocks in the eligible universe must satisfy the following eligibility factors in order to be considered for index inclusion: • Listing History. Stocks must have a listing history of at least six months at BSE. • Trading Days. The stock must have traded on every trading day at BSE during the six month reference period. • Multiple Share Classes. DVRs satisfying the above eligibility criteria are aggregated with the company’s common stock and index construction is done based on the aggregated company data as detailed below. Index Construction • All companies meeting the eligibility factors are ranked based on their average six month float- adjusted market capitalization. The top 75 are identified. • All companies meeting the eligibility factors are ranked again based on their average six month total market capitalization. The top 75 are identified. • All companies identified based on steps 1 and 2 are then combined and sorted based on their annualized traded value. Companies with a cumulative annualized traded value greater than 98% are excluded. • The remaining companies are then sorted by average six-month float-adjusted market capitalization. Companies with a weight of less than 0.5% are excluded. • The remaining companies from step 4 are then ranked based on their average six-month float- adjusted market capitalization, and are selected for index inclusion according to the following rules: - The top 21 companies (whether a current index constituent or not) are selected for index inclusion with no sector consideration. IP and Asset Management – India Specific Page 17

- Existing constituents ranked 22 – 39 are selected in order of highest rank until the target constituent count of 30 is reached. - If after this step the target constituent count is not achieved, then non-constituents ranked 22 – 30 are selected by giving preference to those companies whose sector is underrepresented in the index as compared to the sector representation in the S&PBSE All Cap. - If after this step, the target constituent count is still not achieved, non-constituents are selected in order of highest rank until the target constituent count is reached. Annualized traded value is calculated by taking the median of the monthly medians of the daily traded values over the six-month period. The annualization is calculated using 250 trading days in a year. All additions and deletions are made at the discretion of index committee. Index constituents are weighted based on their float-adjusted market capitalization Index Calculation S&P BSE SENSEX is calculated using the \"Free-float Market Capitalization\" methodology. As per this methodology, the level of index at any point of time reflects the Free-float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization. For each stock an Investable Weight Factor (IWF) is calculated as – IWF = (available float shares)/ (total shares outstanding)where available float shares are defined as total shares outstanding less shares held by strategic holders. The float-adjusted index is calculated as – Index = [Σj (PjSjIWFj)] / Divisor wherePj is the price of stock j, Sj is the total shares outstanding of stock j and IWFj is the investable weight factor. The divisor is the index divisor. National Stock Exchange The National Stock Exchange of India Ltd. (NSE) is the second largest in the world by the number of trades in equity shares from January to June 2018, according to World Federation of Exchanges (WFE) report. NSE launched electronic screen-based trading in 1994, derivatives trading (in the form of index futures) and internet trading in 2000, which were each the first of its kind in India. IP and Asset Management – India Specific Page 18

A stock market index is created by selecting a group of stocks that are representative of the whole market or a specified sector or segment of the market. An Index is calculated with reference to a base period and a base index value. An Index is used to give information about the price movements of products in the financial, commodities or any other markets. Financial indexes are constructed to measure price movements of stocks, bonds, T-bills and other forms of investments. Stock market indexes are meant to capture the overall behaviour of equity markets. Broad-market indices of NSE consist of the large, liquid stocks listed on the Exchange. They serve as a benchmark for measuring the performance of the stocks or portfolios such as mutual fund investments. These are the NIFTY 50 Index, NIFTY Next 50 Index, NIFTY 100 Index, NIFTY 200 Index, NIFTY 500 Index, NIFTY Midcap150 Index, NIFTY Midcap 50 Index, NIFTY Midcap 100 Index, NIFTY Small Cap 250 Index, NIFTY Small Cap 50 Index, NIFTY Small Cap 100 Index, NIFTY Large Mid Cap 250 Index, NIFTY Mid Small Cap 400 Index, and India Vix Index. The NIFTY 50 is the flagship index on the National Stock Exchange of India Ltd. (NSE). It is a diversified 50 stock index accounting for 13 sectors of the economy. The Index has been trading since April 1996 and is well suited for benchmarking, index funds and index-based derivatives. The NIFTY 50 is owned and managed by NSE Indices Limited (formerly known as India Index Services & Products Limited-IISL), India’s first specialized company focused on an index as a core product. The Index tracks the behaviour of a portfolio of blue-chip companies, the largest and most liquid Indian securities. It includes 50 of the approximately 1600 companies traded (listed & traded and not listed but permitted to trade) on NSE, captures approximately 65% of its float-adjusted market capitalization and is a true reflection of the Indian stock market. It is used for a variety of purposes such as benchmarking fund portfolios, index-based derivatives and index funds. NIFTY 50 is owned and managed by NSE Indices Limited (formerly known as India Index Services & Products Limited) (NSE Indices). NSE Indices is India's specialised company focused upon the index as a core product. The index is reconstituted semi-annually considering 6 months data ending January and July respectively. The replacement of stocks in NIFTY 50 (if any) is generally implemented from the first working day after F&O expiry of March and September. In case of any replacement in the index, a four weeks’ prior notice is given to the market participants. The NIFTY 50 is computed using a float-adjusted, market capitalization weighted methodology, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. Beginning June 26, 2009, the NIFTY 50 is being computed using float-adjusted market capitalization weighted method, wherein the level of IP and Asset Management – India Specific Page 19

index reflects the float-adjusted market capitalization of all stocks in the Index. The methodology also takes into account constituent changes in the index and corporate actions such as stock splits, rights issuance, etc., without affecting the index value. The base period for the NIFTY 50 index is November 3, 1995, which marked the completion of one year of operations of NSE's Capital Market Segment. The base value of the index has been set at 1000, and a base capital of Rs 2.06 trillion Price Index Calculation: The NIFTY 50 is computed using the free-float market capitalisation weighted method wherein the level of the Index reflects the total market value of all the stocks in the Index relative to the base period November 3, 1995. The total market cap of a company or the market capitalisation is the product of market price and the total number of outstanding shares of the company. Market information - Capitalization, Turnover and Total Return Index: The market capitalization of a company is in other words the market value of the company’s equity. It is important information that is utilized to decide the company’s segmentation and its relative positioning in the market with respect to its peers. It is used to calculate various financial ratios. Mathematically, it is computed as product of a company’s market price and the number of outstanding shares. Free Float Market Capitalization = Shares outstanding * Price * IWF Index Value = (Current Market Value / Base Market Capital) * Base Index Value (1000) Base market capital of the Index is the aggregate market capitalisation of each scrip in the Index during the base period. The market cap during the base period is equated to an Index value of 1000 known as the base Index value. Total Return Index: The NIFTY 50 reflects the return one would get if an investment is made in the index portfolio. As the NIFTY 50 is computed in real-time, it takes into account only the stock price movements. However, the price indices do not consider the return from dividend payments of index constituent stocks. Only the capital gains and losses due to price movement are measured by the price index. In order to get a true picture of returns, the dividends received from the index constituent stocks also need to be included in the index movement. Such an index, which includes the dividends received, is called the total return index. The total return index reflects the returns on the index from stock prices fluctuation plus dividend payments by constituent index stocks. The total return version of the NIFTY 50 index is also available, which assumes dividends are reinvested in the index on the ex-date. Corporate actions like Dividend IP and Asset Management – India Specific Page 20

announcement do not require any adjustment in the normal price index (other than special dividend). A separate series of index i.e. Total Returns Index (TR) is calculated which shows the returns on Index portfolio, inclusive of dividends. ������������������������������������������ = ������������������������������������������������������������������������������������������∗ [1+((������������������������������’������������������������������������������������+������������������������������������������������������������������������������������������)/������������������������������������������������������������������������������������������ − 1)] Index dividend for the day ‘t’ = Total Dividends of the scrips in the Index / Index divisor for the day Total dividends of scrips in the Index = Σ (Dividend per share * Modified index shares) Modified index shares = Total outstanding shares * IWF * Capping Factor (if applicable) The level of precision for index calculation • Shares outstanding are expressed in units • Investible weight factors (IWFs) are expressed in two decimals • Float-adjusted market capitalization is stated to two decimal places • Index values are disseminated up to two decimal places IP and Asset Management – India Specific Page 21

Chapter-2 : Investment Landscape Learning Objectives Upon completion of this chapter, the student will be able to:  Explain varying markets and key players  Distinguish the investment landscape Introduction This chapter will provide an understanding of the investment landscape in India by further explaining the various markets such as the equity, debt, commodities, foreign exchange, real estate, gold and collectibles markets. The traditional asset classes are considered to be equities, bonds and cash or cash-like securities. It is important for an Investment Advisor to have a strong understanding of the two major stock exchanges in India, the National Stock Exchange and the Bombay Stock Exchange. This chapter will also compare and contrast the differences between promoting and public shareholders. Categories of Issuers Central, State and Local Governments Government securities are issued by the central and state governments to refund the maturing securities for advance refunding of securities that have not yet matured, as well as raising fresh cash resources. RBI mandates banks to maintain a statutory liquidity ratio (SLR) of 18%. The SLR maintained by banks is usually much higher than this ratio. Banks need to invest a certain proportion of their demand, time deposits in government securities (G-Secs) and other approved securities before offering credit. The subscribers in these securities are mostly Banks, Financial Institutions, Provident Fund trusts, Money market Mutual Funds, Primary Dealers, Non-Banking Financial Companies, and Corporate. An investor has the option of holding Government Securities in physical form or book-entry form with RBI permitted SGL constituents, commonly known as Constituent Subsidiary General Ledger (CSGL) IP and Asset Management – India Specific Page 22

account holders. Municipal Bonds are issued by a local government or territory, or one of their agencies. It is generally used to finance public projects such as roads, schools, airports and seaports, and infrastructure-related repairs. Municipal bond market in India is not highly active or mature. Just one or two municipal entities have floated bonds in the last couple of years. Municipal bonds tend to offer significantly higher after-tax yields than corporate bonds with the same credit rating and maturity, investors in higher tax brackets may be motivated to arbitrage municipal bonds against corporate bonds using a strategy called municipal bond arbitrage. High net worth individuals, HUFs, trusts, co-operative banks, and qualified institutional investors prefer to invest in these bonds. Bonds issued by Public Sector Units or PSU Bonds, backed by the Government of India, are usually sold on a private basis. The Government offers the bonds to retail investors at fixed rates. An investment banker usually only serves as a middleman in this situation. Most of the PSU Bonds are sold on Private Placement Basis to the targeted investors at market determined interest rates. Often investment bankers are roped in as arrangers to this issue. These bonds are mostly used to finance large infrastructure projects like toll roads, bridges, etc. Experts suggest that PSU bonds are safe and attractive investment options, even when the issuing PSUs are in a debt crisis, as they have sovereign backing. Many public institutions and provident funds are mandated to invest a minimum 80% of their assets in debt and money market instruments consisting predominantly of debt securities issued by entities such as Banks, Public Sector Undertakings (PSUs), Public financial institutions, and Municipal bonds. Private Sector Companies Private sector companies play an essential role in both urban and economic development. Not only does the private sector contribute to national income, but it also acts as a principal job provider. Essentially, private sector companies determine whether urban areas develop in a sustainable manner, influence poverty reduction and inclusion, and reduce unemployment and instability. Private companies can issue shares to its existing shareholders by way of rights issue or by way of giving them bonus shares or it can issue securities through private placements. They also issue debentures (debt instruments) to raise capital for financing their projects. They are issued by the corporate based on their reputation at a fixed rate of interest. Debentures can be secured in nature; it may be unsecured as well. A secured debenture is secured by the charge on some asset or set of assets IP and Asset Management – India Specific Page 23

which is known as secured or mortgage debenture and another when it is issued solely on the credibility of the issuer is known as the naked or unsecured debenture. Corporate bonds are issued by companies (private and public) to raise capital. Companies use the money to reinvest in their operations; buy other companies; or even pay off or retire loans which are more expensive. Corporate bonds, like all other bonds, offer a fixed interest rate to the bond purchaser. If you hold the bond to maturity, you will receive the principal plus the sum of all the interest paid. They also issue commercial paper (CP), money markets instruments in the form of a promissory note. CPs can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. Commercial papers have become one of the popular routes for corporate to raise funds when compared with loans from banks in recent times. Banks, NBFCs and Financial institutions The major categories of financial institutions include commercial banks, private banks, credit unions, savings, and loans associations, investment banks, pension funds, etc. Banks and Non-Banking Financial Companies (NBFCs) are the two major types of financial intermediaries in any financial system. The NBFCs are often privately owned entities and when the government-owned entities are added, they are classified as NBFIs (Non-Banking Financial Intermediaries). NBFCs are mostly privately owned financial institutions regulated by the RBI and other government entities. Both perform an exceptional role in their respective domains. Banks are a vital part of any economic work. They offer loans, issue debit or credit cards, and ensure the safety of our hard-earned money. A bank account brings financial transactions into the banking sector. There are several types of bank account an individual can open depending on his or her requirement. IP and Asset Management – India Specific Page 24

Mutual Funds Mutual Funds issue units which are securities. They pool money from individual investors, companies, and other organizations and provide credible, easy, robust, professional and least stressful way to invest in the market. A mutual fund can have various kinds of ‘funds’ (called ‘schemes’ in India) under its management. Each scheme issues units to participating investors. As compared to stocks, mutual fund schemes comprise of a more diversified portfolio, lower risk, liquidity, professional management, and tax benefits. Fund managers are professionally qualified and experienced to manage funds. Through structure, investment objective, and plan, mutual funds can be classified in the following manner: The following are the type of products issued by mutual funds: Based on Structure • An Open-ended fund is available for purchase or redemption continuously at the day's closing Net Asset Value (NAV). The key feature of this scheme is liquidity. It is a type of mutual fund that does not have restrictions on the number of units the fund will issue. If demand is high, the fund will continue to issue units no matter how many investors are there. An open-ended fund or scheme is available for subscription and repurchase after the NFO. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices, which are declared daily. IP and Asset Management – India Specific Page 25

• A Close-ended fund issues units during the NFO period only and has a stipulated maturity period. The fund is open for subscription only during a specified period at the time of the launch of the scheme. Price will not depend on the NAV but will depend on the demand and supply situation (just like stocks on the stock exchange), if the scheme is listed on stock exchanges. • An Interval Fund combines the characteristics of both 'open end' funds and ‘closed ended’ funds. They can be bought or redeemed by the investor at predetermined times, say once in six or twelve months. For a specific time, the scheme will be open-ended and the rest of the time it will be close ended. When it is open-ended it is possible to redeem or make additional purchases otherwise not. When closes ended then it must be listed on the stock exchange. When it becomes open-ended that period is called the transaction period (min 2 days). The gap between two transaction periods is called the interval period (min 15 days) Based on Asset Class • Equity Funds invest in the stocks of different companies. Equity mutual funds are good for investors who do not have the time or knowledge to invest in the Stock Market directly and who wish to avoid the fluctuations and volatility of the stock market and whose risk appetite is not so high. Investors can invest a nominal sum of money into this type of mutual fund and get a taste of the stock market and have their portfolio managed by experienced Fund Managers and CIOs. The types of funds invest in companies based on their market capitalization. Large Cap Funds – Investments are made in the top 100 companies on basis of their market capitalization. The returns in large-cap funds are relatively stable compared to other types of equity mutual funds because investors have confidence in large conglomerates and therefore risk exposure is relatively lower. Mid Cap Funds – The companies ranged from 101 to 250 in terms of market capitalization are known as mid-cap companies. Money is invested into developing companies with a decent footing in the industry. The risk is less than small-cap funds and more than largecap funds. The growth potential is also higher in these types of funds. These are the bluechip stocks of the future. Small Cap Funds – 251st company onwards in terms of full market capitalization are known as small- cap companies. These funds are risky and volatile, and the returns offered are way higher than the above two funds. These companies have a lot of future scope for growth. IP and Asset Management – India Specific Page 26

Multi-Cap Funds – These are funds that invest in shares of companies with varying market caps. The portfolio of multi-cap funds is diversified. Less risky than funds that solely invest in mid, large, or small- cap. Good for investors who do not want to put their eggs in just one basket. Therefore, in the long run, multi-cap funds are usually better wealth creators than other categories as they can take advantage of investment opportunities across market caps Income/Debt funds –These funds invest in fixed-income investments like bonds, Govt. securities, and treasury bills ETFs, etc. The main objective of this type of fund is to provide a guaranteed return to investors who have low-risk appetite. The principal amount invested has better chances of protection from erosion in such funds and they have a certain interest income, if so opted. Debt Funds are provided Ratings by Rating Agencies. Money invested in these funds is fairly liquid. Accrual Funds – Here, interest income is earned on the coupon that is offered on the bonds. They are passively managed with objective to hold high yielding securities till their maturity. Liquid Funds – Money is invested into very short-term money market instruments. It is very liquid. There is no exit load and the returns are around 7% per annum. It holds the least amount of risk. It is advisable to invest in this kind of fund, when one gets a large sum of cash (lump sum) or when someone needs cash in the immediate future and wants his money to grow at a decent interest rate for that duration. Short Term Funds – Money is invested in money market securities with little risk. Money is parked in this type of fund because it is highly liquid and can be used as a contingency fund. Hybrid funds– These funds combine a stock component, a bond, and sometimes a money market component. They tend to specify the maximum allocation to equity instruments, between 30% to 70% generally, though the allocation can vary at extremes. They invest the remaining in fixed income securities. A balanced fund is for investors who are looking for some mixture of safety, income, and modest capital appreciation. REITs and InvITs A Real Estate Investment Trust (REIT) is a platform approved by SEBI in which the money will be pooled from the investors across the country. The money thus collected is invested in commercial properties to generate income. The main target of REITs is shopping malls, hotels, nursing homes, etc. In India, REITs are not allowed to invest in residential properties. It is a process where funds are generated from the investors’ money and directly invested in profitable real estate properties. REITs are listed in stock exchanges and structured just like trusts. IP and Asset Management – India Specific Page 27

A REIT must be issued through an IPO (Initial Public Offering). Key objectives • Provide investors with dividends that are accumulated from the capital gains accruing from the sale of commercial assets. • 90% income of the investors is paid via dividends. • Provides diversified and safe investment opportunities under a professional management. Tax Implications • Dividends received by REIT and the investors are exempt. • Capital gains earned by REIT for sale of share of SPV are applicable at the rates of capital gains and exempt for unit holders. • Capital gains earned by unit holders on sale of REIT unitsShort term- 15% Long term- 10% more than Rs 1 lakh without indexation benefit Advantages • Regular dividend- Investors can earn dividends from the 90% of the income. • Diversification- As per the guidelines, REIT must invest in minimum of 2 projects. • Transparency- It will showcase the full valuation half yearly or yearly basis. Infrastructure and real estate are the two most critical sectors in any developing economy. A well- developed infrastructural set-up propels the overall development of a country. It also facilitates a steady inflow of private and foreign investments, and thereby augments the capital base available for the growth of key sectors in an economy, as well as its own growth, in a sustained manner. Given the importance of these two sectors in the country, and the paucity of public funds available to stimulate their growth, it is imperative that additional channels of financing are put in place. An Infrastructure Investment Trust (InvITs) is Collective Investment Scheme like a mutual fund, which enables direct investment of money from individual and institutional investors in infrastructure projects to earn a small portion of the income as return. Tax Implications • Capital gains realized on the transfer of units of unlisted private InvITs shall be taxable at the rate of 10% (plus applicable surcharge and cess) in hands of a non-resident unit holder and 20% (plus applicable surcharge and cess) for the resident unit holder, provided the units have been held for more than 36 months. The short-term capital gains (where units have been held for IP and Asset Management – India Specific Page 28

less than or equal to 36 months) will be taxed at the rate of 30% (plus applicable surcharge and cess) for residents and 40% (plus applicable surcharge and cess) for non-resident corporate. Non-resident unit holders may claim the beneficial provision available under the applicable double tax avoidance agreement (“DTAA”) if any. Long term capital gains arising from the market sale of listed units, both in the hands of residents and non-residents, are taxed at the rate of 10% (plus applicable surcharge and cess) on gains exceeding `Rs.1,00,000 while short-term capital gains will be taxed at the rate of 15% (plus applicable surcharge and cess). • DDT (Dividend distribution Tax) is applicable on InvITs. Advantages • Diversification- Investors get the opportunity of having a diversified portfolio • Liquidity- It is easy to enter and exit from InvITs which enhances its liquidity aspect • Quality asset management- InvITs offers investors the opportunity to get them assets managed professionally. Alternate Investment Funds (AIFs) An alternative investment fund is a financial asset with high threshold investment of at least Rs 1 crore and is subscribed by institutional investors or accredited high-net-worth individuals because of their complex nature, and degree of risk. Alternative investments include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Many alternative investments have high minimum investments and fee structures, especially when compared to mutual funds and exchange-traded funds (ETFs). These investments also have less opportunity to publish verifiable performance data and advertise to potential investors. Although alternative assets may have high initial minimums and upfront investment fees, transaction costs are typically lower than those of conventional assets, due to lower levels of turnover. There are there categories of AIFs: Category I: Funds that invest in Start-ups, Small and Medium Enterprises (SMEs), and new businesses which have high growth potential and are considered socially and economically viable are part of this category. The government promotes and incentivizes investment in these projects as they have a multiplier effect on the economy in terms of growth and job creation. IP and Asset Management – India Specific Page 29

These funds have been a lifeline to already thriving start-ups starving for capital. Category II: of the Alternative investment Fund includes those funds which are not in the first and third categories of Alternative Investment Funds and which also include private equity funds and debt funds. Category III: funds include hedge Funds and Debt Funds. Alternative Investment Fund Category 3 shall not be included in regulation 3 and 3A of SEBI regulation 1992 in case of investment rules need to satisfy certain conditions: Equity Markets Equity market is where equity shares are traded, usually through exchanges and sometimes over the counter. In the previous chapter, you learnt about capital markets in which, equity markets play a great role. But, within the capital market segment, there is another market called the Over the counter (OTC) market. Over the counter refers to a network of brokers, dealers and investors, which facilitates trades between two parties outside the exchange. The OTC market deals with companies that are not listed on an exchange as they are not large enough to bear the costs and meet the requirements of getting listed on an exchange. The price, quality and quantity of the deliverable are negotiated by the parties or the intermediaries on behalf of the buyer and seller. Because of their unregulated nature, both parties bear potential risk. Besides equity, securities such as bonds and derivatives also are traded and settled through the OTC network. In spite of its significance and existence for very long time, the percentage of trades carried OTC are meagre in comparison to the numbers that occur through exchanges. In the modern world, almost all securities in the secondary market are traded through exchanges Role played by different investors in the market Market consists of a multiplicity of players, basically categorized into institutional investors and retail participants; and also categorized into investors to traders. All of them have a different purpose and lend their own texture to stock markets. Retail investors have generally long-term interests in the market, either investing directly or through mutual fund route or other collective investment schemes like Portfolio Management and Alternative Investment Funds. It however does not mean that they do not have short term interests in the market. Institutional investors have their own policies and agenda in the stock markets. IP and Asset Management – India Specific Page 30

Let us examine their role more methodically as follows: Retail Investors and High Net worth Investors The retail investors provide equity capital to corporate which is of more stable nature as such capital do not change hands often. At the same time equity capital held by retail shareholders provides free float in a way it is not locked-up as promoter’s quota and is eligible for fee trading. Companies which fear hostile takeovers have solace in this stable holding with the public as the public is large in numbers and is varied to have impact of cartelization or syndicates. Retail investors play a crucial role in building the stock market and, thereby, the economy of a country. High net worth Investors have net worth in excess of $ 1 million excluding their primary residence and consumables. They are very active in markets and choose wealth management products like portfolio management schemes where they have a higher say in the constituents of Portfolio, or Alternative Investment Funds where they can take long-term bets in private equity and start-ups. According to Prime Database, the holdings by retail investors as at 31 March 2021 is reckoned at 13.63 lakh crore Mutual Funds and Domestic Institutional Investors (DIIs) Mutual funds have close to Rs 14.30 lakh crore in equity funds. Compared to the total market capitalization, this seems a miniscule 7% of total equity holdings. It is growing in size with the equity culture on the rise. This average 5% should not be the right percentage as a large percentage of mutual fund holding is concentrated in highly liquid blue chip stocks, and there this percentage may be material enough to stabilize large swings in the respective counters when under selling pressure by some interested groups. The domestic investors also include life insurance companies, provident funds, pension funds, NPS and banking and financial institutions. They collectively have huge funds. Even a small percentage directed toward stock markets means a sizeable chunk of total market capitalization. Prime Database figures for March 2021 state DII holding of equity to the extent of Rs 25.75 lakh crore, or a little over 13% of total market capitalization of equities. Foreign Portfolio Investors Foreign Portfolio Investors are an important segment of Indian stock markets. India being a growing economy and one of the top emerging economies has attracted the money of foreigners who invest in Indian markets by way of portfolio investments, pension funds, hedge funds, etc. They have both long- term view of the markets (portfolio investments and pension funds) as well as short-term views (hedge IP and Asset Management – India Specific Page 31

funds). Many hedge funds use the ETF route to take exposure in Indian equity markets. Leading indices therefore become very volatile when these funds enter or exit our markets in directional investments. The Prime Database reckons total FPI investments in Indian markets to an AUM of Rs 44.66 lakh crore as at March 2021. This is well in excess of 20%. Promoters Holding by private promoters in companies is one major chunk. It has been observed that over a decade this holding has been steadily rising from nearly 35% to 45% of total equity value of the markets. This has been aided by new listings on the stock markets. The Prime Database maintains this figure as of March 2021 at Rs 88.63 lakh crore. This includes to the extent of 9% held by foreign promoters. The President of India holds the equity held by the government in Public Sector Enterprises and banks. Shareholding Pattern – What does it indicate? Shareholding pattern of a company throws light on a company’s performance and expectations about the future, whether good or bad. When investing in equity, the changes in shareholding pattern give valuable insights. Shareholders for this purpose are generally categorised into Promoter Group and Public. Promoters are the individuals or organisations that established or promoted a company. Normally, a majority of the board of directors are from the promoter group, which includes the kin of the promoters. Public shareholders are more diversified. They can be institutions such as Foreign Institutional Investors (FII), Domestic Institutional Investors (DII) such as mutual funds, insurance companies, financial institutions, Foreign Direct Investment (FDI) or individuals such as the High Net-worth Individuals and Retail investors. Investors, among studying other information, must also compare promoter and institutional shareholdings quarter-onquarter. When foreign institutional investors buy a stock, it brings in optimism and the share price of that company surges. Likewise, when FIIs sell a company, it sends negative signals and lead to a sharp drop in the share price on the exchanges. This holds true for other institutions also such as mutual funds. A high promoter stake is generally looked upon as a positive. However, a well-diversified shareholding across different types of investors means that the promoters have little scope to take unwarranted decisions that can hurt the business. IP and Asset Management – India Specific Page 32

An increase in promoter shareholding is an indication of the increased confidence of the promoter in the business growth. A decrease in promoter holding must be studied carefully but not immediately looked upon as a negative for the business or the company. In the 2019 budget, there was a proposal to increase the public shareholding to thirty-five per cent from the existing twenty-five per cent. Investing in Equity Shares – Shareholders’ Rights Depending on their approach, traders in the securities markets are generally classified as Investors, Speculators and Arbitrageurs. All types of traders can be all three at all times i.e. a trader can buy shares of one company with objective of making a long term investment, generally in which case he is called as an investor (his action, investment); trade in the stock with a view to gain from the volatility in the short term, in which case he is called a speculator (his action, speculation); and trade in the same stock in two different markets and benefit from the momentary price differences, in which case he is called an arbitrageur (his action, arbitraging). General Meetings: Companies must hold Annual General Meetings (AGM) once every year. There must not be a gap of more than fifteen months between consecutive yearly AGMs. Equity shareholders hold the right to be informed of the meetings. They also have a right to vote favouring or against resolutions proposed at such AGM. The same holds true for Extraordinary General Meetings (EGM) also. Preference shareholders do not have any voting rights. Dividends: Besides the right to vote for declaring dividends in an AGM, equity shareholders have a right to be paid such dividend out of the distributable surplus. Such dividends are payable within thirty days from the date of announcement. However, Preference shareholders are first paid a fixed interest before equity shareholders are paid any dividend. Any unpaid dividends are transferred to a separate bank account meant for the purpose. Share Transfer: Except in cases where the Board of a private limited company, through the Articles of IP and Asset Management – India Specific Page 33

Association, prohibits transfer of shares by certain members, shareholders of a company generally have the right to freely transfer the fully paid up shares they hold. Amending Key Documents: Memorandum of Association (MOA) and Articles of Association (AOA) are defined the business nature and functioning of a company. Any amendments to such documents can be made only through a general meeting, if voted in favour by a majority of shareholders. Specific amendments to these require approval of at least seventy-five per cent of shareholders. Convene Meeting: In the event of receiving a request from shareholders holding at least ten per cent paid-up capital, the Board of the company must convene an Extraordinary General Meeting (EGM). Such a meeting must be called by the Board not later than twenty-one days and held the meeting not later than forty-five days from the date of receiving such requests. On the failure of the Board to hold such an EGM, the shareholders can call the meeting themselves. Minority Shareholders: If any unprofessional conduct or mismanagement is suspected, to protect themselves, minority shareholders can complain to the Company Law Board. However, for the purpose, a minimum of a hundred shareholders collectively holding not less than ten per cent of the total paid up capital of the company must come together. If the Company Law Board upon investigation finds fault with the majority shareholders or the management, it passes suitable order. Equity Derivatives Market – Indicators and Pricing Mechanism The word derivative means derived i.e. the value is derived from something else. A Derivative is a contract whose value is derived from the value of some other asset. The asset from which the value of a derivative is derived is called an Underlying. These underlying assets can by anything such as equity, bonds, commodities, currencies, metals, gold etc. There are four types of derivative products viz. Forwards, Futures, Options and Swaps. A Forward contract between two parties allows them to buy or sell an underlying asset on a future date, for a certain mutually agreed, pre-decided price. Regardless of the change in the price of the underlying, either party is obliged to honour the contract on the future date. Forwards are not traded on the exchanges and thus, over the counter contracts. A forward contract that is traded through a recognized exchange is called a Future. An Option contract gives the buyer the right to buy or sell a mutually agreed quantity of an underlying on or before a certain date at a pre-determined price. However, the option buyer is not obliged to honour the contract if on or before the future date he feels that the position is not favourable for him. IP and Asset Management – India Specific Page 34

To exercise the right and not be obliged to honour the contract, the option buyer pays a premium to the seller. On the contrary, the seller of an option has an obligation but not the right to buy or sell the underlying as per the contract, for which, he receives a premium as compensation. Swaps are a series of forward contracts created to manage interest rate volatility. Swaps are agreements that allow future cash flows between two parties In the year 2000, the regulator SEBI permitted the exchanges BSE & NSE to launch equity derivatives. On June 9, 2000 by launching the first Exchange-traded Index Derivative Contract in India i.e. futures on the capital market benchmark index - the BSE Sensex. The National Stock Exchange of India Limited (NSE) commenced trading in derivatives with the launch of index futures on June 12, 2000. NSE introduced trading in Index Options (also based on Nifty 50) on June 4, 2001. It launched trading in options on individual securities from July 2, 2001 and Futures on individual securities on November 9, 2001. BSE commenced trading in Index Options on Sensex on June 1, 2001, Stock Options were introduced on 31 stocks on July 9, 2001 and Single Stock Futures were launched on November 9, 2002. BSE also introduced Long Dated Options on Sensex on February 29, 2008, whereby the Members can trade in Sensex Options contracts with an expiry of up to 5 years. On October 1, 2008 BSE launched its currency derivatives segment in dollar-rupee currency futures as the exchange traded currency futures contracts facilitate easy access, increased transparency, efficient price discovery, better counterparty credit risk management, wider participation and reduced transaction costs. On the other hand, the OTC derivatives markets have witnessed rather sharp growth over the last few years, which has accompanied the modernization of commercial and investment banking and globalisation of financial activities. The recent developments in information technology have contributed to a great extent to these developments. While both exchange-traded and OTC derivative contracts offer many benefits, the former have rigid structures compared to the latter. It has been widely discussed that the highly leveraged institutions and their OTC derivative positions were the main cause of turbulence in financial markets in 1998. These episodes of turbulence revealed the risks posed to market stability originating in features of OTC derivative instruments and markets. The OTC derivatives markets have the following features compared to exchange traded derivatives. 1. The management of counterparty (credit) risk is decentralized and located within individual institutions 2. There are no formal centralized limits on individual positions, leverage, or margining IP and Asset Management – India Specific Page 35

3. There are no formal rules for risk and burden-sharing 4. There are no formal rules or mechanisms for ensuring market stability and integrity, and for safeguarding the collective interests of market participants, and 5. The OTC contracts are not regulated by a regulatory authority and the exchange's self- regulatory organization, although they are affected indirectly by national legal systems, banking supervision and market surveillance. Some of the features of OTC derivatives markets embody risks to financial market stability. The following features of OTC derivatives markets can give rise to instability in institutions, markets, and the international financial system. i. The dynamic nature of gross credit exposures ii. Information asymmetries iii. The effects of OTC derivative activities on available aggregate credit iv. The high concentration of OTC derivative activities in major institutions; and v. The central role of OTC derivatives markets in the global financial system. Instability arises when shocks, such as counter-party credit events and sharp movements in asset prices that underlie derivative contracts occur, which significantly alter the perceptions of current and potential future credit exposures. When asset prices change rapidly, the size and configuration of counter-party exposures can become unsustainably large and provoke a rapid unwinding of positions. There has been some progress in addressing these risks and perceptions. However, the progress has been limited in implementing reforms in risk management, including counterparty, liquidity and operational risks, and OTC derivatives markets continue to pose a threat to international financial stability. The problem is more acute as heavy reliance on OTC derivatives creates the possibility of systemic financial events, which fall outside the more formal clearing house structures. Moreover, those who provide OTC derivative products, hedge their risks through the use of exchange traded derivatives. In view of the inherent risks associated with OTC derivatives, and their dependence on exchange traded derivatives, Indian law considers them illegal. IP and Asset Management – India Specific Page 36

Futures and Options Futures Spot Price is the price at which an underlying asset trades in the cash segment. Future Price is the price at which a future contract trades in the future market. The day on which a contract expires is called the expiration date. All future contracts expire on the last Thursday of the month unless they are rolled over to the near month through cash settlement. All derivative contracts are traded in lots. A lot contains a certain number of underlying assets. The contract value is arrived at, by multiplying the lot size with the contract price. The difference between spot price and future price is called Basis. Basis is considered positive if the spot price is higher than the future price. It is negative, if the future price is higher than the spot price. Carrying cost or the cost of carry in case of equity derivatives is the interest paid on the borrowed amount less income earned in the form of dividend. In case of commodities, the cost of storage is also added to this. Cost of carry fills the gap between the spot and future prices. Before getting into a future contract, one has to make an initial deposit called Margin. For example, say you expect the Nifty to go up. On 09-Dec-2019, the Nifty Futures price closed at 11966.70. As you are bullish, you go long on Nifty Future Dec-2019 contract that will expire on 26-Dec- 2019. The lot size is 75. So, the contract value is 11966.70 * 75 = 897502.50. Suppose the margin percentage is 10, you need to pay 89,750.025 as Margin. Higher the volatility in the price of the underlying, higher the initial margin payable. And, margin is payable by both buyers and sellers of futures. Suppose on 10-Dec-2019 Nifty Future closes at 12000. The difference of 12000 - 11966.70 = 33.30 is your profit per Nifty i.e. on a lot of 75, the total gain is 75 * 33.30 = 2497.50. The profit will be credited to your account. However, if you incur a loss, you will have to bring in the additionally required margin. This daily adjustment is called Mark to Market (MTM). At any point in time, there are always equal number of long contracts (buy) and short contracts (sell). The total number of contracts (either long or short) that are due to be settled for a certain underlying is called Open Interest. Over a given period, this volume of trades or open interest tells us what the depth and activity surrounding a particular contract is. Long or short position in any contract that is not yet settled or closed is called Open Position. While there are various methods of pricing futures based on the demand, supply and features of the underlying assets. Two well-known models methods of pricing futures are the Cash and Carry model and the Expectancy model. Cash and Carry is based on the hypothesis of efficient markets and adopts that arbitraging IP and Asset Management – India Specific Page 37

opportunities are short lived due to the trading by opportunistic arbitrageursin order to monetise the price differences Futures Price = Spot Price + Cost of Carry Suppose the price of the company ABC in the cash market is 250. The cost of carrying this for three months is Rs. 10. If you purchase the shares for Rs. 250 today, you can say that the price will be Rs. 260 after three months. If the 3-month ABC future contract trading at Rs 275 one should try to benefit from the price difference by buying the shares in the cash market (for a low price of 260) and simultaneously sell three-month futures (for high price of 275). You borrow 250, take delivery in cash market and after three months, sell in the futures market on the expiry of the future contract for 275. Out of the difference of amount received you repay the borrowed money and 10 towards interest and insurance and retain a net gain of Rs. 15. When more people trade this way, it will bring down the future price while the spot price goes up thereby removing the price differences between the markets and eliminating arbitraging opportunities. If future price is lower than the sport price, reverse cash and carry arbitrage opportunity arises. Suppose there are inflows from the investment in the form of dividends, future fair price is calculated as follows. Future fair price = Spot Price + Cost of Carry – Dividend or Interest This can be also written as F = S * (1+r-q) ^ t Here, F is the future price, S is the spot price, r is the cost of carry, q is the expected return and t is the time or the period of holding in years. Cost of carry includes the cost of storage costs, financing, insurance, etc. In case of continuous compounding, the above formula is written as F= Se^[(r-q)*T]. In case of Index Futures, the future price is calculated as follows. Future Price = Spot price (1+cost of financing – holding period return) ^ (time to expiration/365) The fundamentals of derivative contracts are the common for all underlying assets be it equity shares or indices or commodities. Most financial derivatives are generally cash settled but some commodities contracts are settled by physical delivery, which may require storage or warehousing arrangements IP and Asset Management – India Specific Page 38

Options An Option is comparable to a forward or future contract but with an option or right. An option contract gives its buyer the right but not an obligation to buy or sell the underlying asset. Conversely, the seller/writer of an option is obliged to honour the contract. The buyer of an option exercises his option or right when the position is in his favour. In such a case, the writer of the option is bound to honour the contract. Options are of two types. The option that gives the buyer a right but not an obligation to buy an underlying is called a Call Option and the option that gives the buyer a right but not an obligation to sell an underlying is called a Put Option. Options that have an Index as an underlying are Index Options while those that have individual stocks as underlying are Stock Options. Options, in which case the buyer can exercise the right any time on or before the expiry date are American Option type. If the buyer of an option can exercise the right/option only on the expiry date, such options are European Option type. In India, Index Options are European type. All monthly derivative contracts, be it futures or options, expire on the last Thursday of the month. In the second half of 2019, NSE and BSE introduced weekly options that are index based, to start with. Weekly derivatives expire on Thursday every week. However, for the weeks where the last Thursday for monthly contracts and the Thursday for weekly contract coincide, new weekly contracts are not generated. Spot price (S) is the price at which the underlying trades in the spot market. Strike price or Exercise price (X) is the option contract price per share for which the underlying is bought or sold. A call option is said to be ‘In the money’ (ITM) if the spot price is higher than the strike price. A put option is said to be “In- the- money” if the strike price is higher than the spot price. If exercised immediately, an ‘In the money’ position gives the holder positive cash inflow. If spot price and strike price are both equal, the position for both Call and Put options is ‘At the money’ (ATM). For a call option, if the spot price is lower than the strike price, the call option is said to be ‘Out of the money’ (OTM). For a put option if the strike price is lower than the spot price, the put option is said to be out of the money. In case of out of the money position, exercising the option leads to a negative cash flow for the holder. For the right he enjoys a buyer of a call or a put option pays a price called Premium to the seller/writer of the option. Option premium consists of Intrinsic Value and Time Value. If written in the form of an equation, it is as below. Option Premium = Intrinsic Value + Time Value IP and Asset Management – India Specific Page 39

Only In the money options have intrinsic value. For at the money and out of the money options, the intrinsic value is zero. Intrinsic value is never negative. Intrinsic Value of a Call = S-X Intrinsic Value of a Put = X-S At the money and Out of the money options have only Time Value but not any intrinsic value. Costs, Benefits and Risk of Derivatives The traders in the derivatives markets can be; Hedgers, ones who use their hedging trade to offset a business or market risk, the risk could be the exposure to a commodity, an interest rate, a currency or stocks; Arbitrageurs, ones who use an arbitrage trade to take advantage of a mispriced relationship that exists between a derivative and its referenced commodity, currency, interest rate or security; and Speculators, ones who use a speculative trade to profit from market price fluctuations by usually taking a contra position or opposite side of a hedging or arbitrage trade. They may have varying interests, risks, views about relative movement, and divergent risk tolerance. The primary role of derivatives, the way these were conceived, is to hedge risks of loss in a given exposure, be it a commodity, an interest rate, stock market, present or likely currency obligation, etc. That is, derivatives are tools to prevent a perceived loss rather than making profits as can be seen from the other two roles of Arbitrageurs and Speculators. One benefit of derivatives obviously is liquidity and price discovery, but that is in a larger market scenario. How the costs and benefits pan out at a retail level vis-à-vis the associated risks, is of essence. One aspect of derivatives is leverage. It allows one exposure to a large enough value disproportionate to the costs involved. But it is a double-edged sword. Whereas it has gains multifold, the losses are equally huge. So, the costs involved vis-à-vis exposure is minimal whereas the risk of losses is very scary. We are blinded by the costs to the value that can be gained, and here lies the risk. If the situation is not closely monitored and losses not cut in time, the liability can be humongous. That is why it is easy to pocket the premium in options trading, but in a reversal of scenario, the losses can wipe out all business gains in one trade. It is the job of professionals who have a built-in cushion to absorb the downside while they have access to the best research on directional movement of technical on a moment-to-moment basis in volatile markets. And it has costs as well. With advancement in technology which favours large institutions and sophisticated traders having the access, the tide is against an amateur trader in F&O segment. There are arbitrage funds which a retail investor can rely on to have equity treatment of debt-like gains. Professional fund managers have the access to technology and the required skill sets to IP and Asset Management – India Specific Page 40

accomplish that. Speculation is not recommended for retail investors though the lower costs of exposure may lure them into trading. They can win in few trades, but losses in others can wipe out their entire gains. Hedging of portfolios and other exposure is the best use of derivatives. It has costs of those hedging that sometimes stick. However, in expected directional movement for which he hedging is resorted to, the protection to portfolio value or the expected business situation is a phenomenal benefit vis-à-vis costs of hedging. Index Futures vs Index Options vs Index Funds Index future and Index option are derivatives on a certain Index, say Nifty 50, Bank Nifty, etc. Index futures/options are different from specific stock futures/options in that one can have a consolidated view of the market than individual stocks, and hence avoid stock specific and Sectoral risk. It provides natural diversification when having a view on the directional movement of the market. The maximum period can be a 3-month trading cycles. On lower side they can be the near month (1 month) or the next month (2 months). If one is positive about the upward direction of equity markets, one can go long (buy) on index futures, and vice versa. Index futures have a future level or index and an expiry date (settlement date). While dealing in index futures, margins are paid, per traded lot size basis, to the exchange by the seller as well as the buyer to enter a futures contract. They are exchange settled, i.e. the counterparty in every futures transaction is the exchange. Because of margins which allow bets of value in high multiples, the total outlay involved in trading is low while taking large directional stakes. The margins on index futures are even lower than individual stock futures. The purpose of index futures is to have speculative bets on market direction. In the same way, a portfolio of stocks can be hedged to protect value in case of expected adverse movement in the market. For instance, a portfolio of Rs 100 crore can be hedged by selling index futures if there are indications that the market would correct in the short-term but the long-term direction would stay intact. If say a 10% correction is expected over the next 3 months, the equivalent value of index futures may be sold. If the market actually goes down, one books profit on the Index futures which helps cover the actual loss in the portfolio value. Index futures have ample liquidity with much lower trading costs. They are all settled in cash, i.e. they are either squared before the settlement/expiry date or rolled over to the next settlement. They also impose an obligation on buyer as well as the seller to settle the trade. They have marked-to-market mechanism whereby an individual would be required to bring in more cash if the margins fall short on day-to-day basis due to adverse direction of the market than the intended one. IP and Asset Management – India Specific Page 41

Index options are another form of derivatives which give the buyer of option the right, but not the obligation, to buy or sell (exercising of option) an index (number of lots, usually lot size is 25) at a predetermined level on or before the chosen settlement date on which the index option expires. The option to buy an index level is termed a ‘call’, while the option to sell the same is termed a ‘put’. The buyer of an index call/put option therefore pays a premium to secure a right to buy/sell certain lots of predetermined index level on or before the settlement date. On the other side, the seller of such index options, termed ‘writer’ receives this premium and enters into an obligation to sell/buy those lots either on expiration date or at any date prior to the expiration date on the instance of the buyer of index option. Like index futures, index options can also be used to either bet on the directional movement of markets or hedging market exposures. If the index call/put options are not ‘in the money’ the buyer can lapse the option to settle and the liability is limited to the premium paid in buying those lots. On the other side of the trade, the writer of index call/put options has the upside limited to the premium received as long as the options are ‘out of money’. Their liability can be unlimited in case of huge unidirectional market movement when index options trade ‘in the money’. Like index futures, index options are also exchange settled in cash. The costs in index futures are less than index options as the options premium cost a little more for the buyer at a reduced risk (of the obligation to settle). The seller (writer) of index options receives the premium but is at a very high risk. The risks have to be managed well while taking exposure to market through index futures and index options. However, they are lower than individual stock futures/options due to the diversification and liquidity benefits. Index funds or Exchange Traded Funds by mutual funds are in the form of units issued. The new fund offers (NFO) for index funds are at par value Rs 10 which represents the level of an underlying index (Nifty50, Bank Nifty, Sensex, etc.) at the time of NFO. The subsequent levels of index fund price are represented by the net asset value (NAV) which closely corresponds to the underlying index level (rise/fall). As the index is mirrored in portfolio, i.e. the stocks in the portfolio are in the same value proportions as they are in the underlying index (by way of relative market capitalization), there is no active management. Hence, the fund management costs are the least. Investors who want a cost-efficient exposure to equity markets in the long run may opt to go with index funds. The ETFs also map specific individual stock indices. They, as the name suggests, have the additional advantage of trading on stock exchanges. IP and Asset Management – India Specific Page 42

While an index fund can be bought or sold at the closing level of index on a certain trade date, ETFs can be traded at intra-day levels. As index funds and ETFs closely track or mirror their underlying indices, their performance is measured by tracking error, which is usually in the range 0.5%-0.75%. There is no fixed horizon for holding index funds. They can be held for unlimited period and can be bought/sold on all trading days at prevailing NAV linked prices or market prices (for ETFs). The total expense ratio of index funds in regular plans can be in the region of 0.75%, and just 0.25% in direct plans. This is against 1.75% - 2.25% expense ratio in the equivalent managed large cap funds and diversified growth schemes. The risk managed is fund manager risk, both on the up and down sides, while the market risk also applies on index funds and ETFs. Debt Markets Debt Market is where various types of fixed income securities are issued and traded. These securities are generally issued by Governments, Municipal Corporations, Banks, Businesses, and Financial Institutions, etc. Fixed Income securities provide a fixed stream of incomes or cash inflows in the form of interest or dividend for a predefined term at the end of which, the principal investment is repaid. These securities are issued by entities against the moneys lent to (or invested) these institutions and they generally offer a fixed rate of return. Some of these instruments are secured by way of attachment to certain fixed assets of the issuing organisation. By diversifying some investments into low return but risk-free government securities, one can minimise the default risk that is inherent to some debt securities and protect the overall portfolio of investments. Also, in comparison to the securities of other asset classes such as equity, theoretically debt instruments have lower risk and relatively higher safety. The Money Market is an integral part of the broader debt segment. It deals with the issue and trading of securities with short term maturity. Some money market instruments are Treasury Bills, Bonds, Certificates of Deposits (CD), and Commercial Papers (CP) etc., which have maturity not exceeding one year from the date of original issuance. Depth of Debt Markets and Key Players The secondary debt market has two segments viz. Wholesale Debt Market and Retail Debt Market. Primary dealers, financial institutions and banks, mutual funds and insurance companies, foreign investors etc. participate in the wholesale debt market. In the retail debt market, retail investors i.e. individuals, trusts, provident and pension funds etc. are the common participants. Banks and financial institutions were the key players in the wholesale market but over a period, with the government allowing foreign entities to invest up to hundred per cent in the debt segment and allowing them to IP and Asset Management – India Specific Page 43

invest in treasury bills, the varieties of investors or participants largely increased. In the wholesale segment, an outright purchase or sell transaction is an independent trade without any connection to any other trade whatsoever. A Repo or a Repurchase trade is done with the objective of reversing the transaction in the future for an interest rate calculated for the period between the execution dates of the Repo and Reverse Repo transactions. As both transactions occur between the same parties, from the perspective of one party if it is a repo, for the other it is a reverse repo and it is vice versa for the reverse transaction. Though repo and reverse repo transactions occur in the money market among banks and financial institutions, largely, they are more common between the commercial banks and the central bank and help in managing the liquidity in the economy. The Fixed Income Securities market was the earliest of all the securities markets in the world and has been the forerunner in the emergence of the financial markets as the engine of economic growth across the globe. The Fixed Income Securities Market, also known as the debt market or the bond market, is easily the largest of all the financial markets in the world today in terms of market capitalisation. The Debt Market has, as such, a very prominent role to play in the efficient functioning of the world financial system and in catalysing the economic growth of nations across the globe. The Debt Market plays a very critical role for any growing economy which needs to employ a large amount of capital and resources for achieving the desired industrial and financial growth. The Indian economy which has grown at more than 7% p.a. in the last decade and is on the take off stage for double digit growth would have to meet its resources requirements from robust and active debt market in India. As per the Central Bank and the Clearing Corporation, the Indian debt markets with an outstanding issue size of Government securities (Central and state) close to Rs. 19,74,467 crores (USD 421.35 billion) and a secondary market turnover of around Rs. 30 lakh crores (USD 640.20 billion) for the year 2009 is the largest segment of the Indian financial markets. The Government Securities market called 'G-Sec' market is the oldest and the largest component of the Indian debt market in terms of market capitalization, outstanding securities and trading volumes. The G-Secs market plays a vital role in the Indian economy as it provides the benchmark for determining the level of interest rates in the country through the yields on the government securities which are referred to as the risk-free rate of return in any economy. In order to accomplish the objective of meeting the Government borrowing needs as cheaply and efficiently as possible, a group of highly qualified financial firms/ banks are appointed to play the role IP and Asset Management – India Specific Page 44

of specialist intermediaries in the G-Sec market between the issuer on the one hand and the market on the other. Such entities are generally called Primary dealers or market makers. In return of a set of obligations, such as making continuous bids and offer price in the marketable G-Secs or submitting reasonable bids in the auctions, these firms receive a set of privileges in the primary/ secondary market. Besides G-Sec market, there is an active market for corporate debt papers in India which trade in short term instruments such as commercial papers and certificate of deposits issued by Banks and long term instruments such as debentures, bonds, zero coupon bonds, step up bonds etc. As per SEBI, the outstanding issue size of listed corporate debt paper was Rs. 2.2 lakh crores in 2009 (USD 46.95 billion). The Debt Markets in India and all around the world are dominated by Government securities, which account for between 50 - 75% of the trading volumes and the market capitalization in all markets. Government securities (G-Secs) account for 70 - 75% of the outstanding value of issued securities and 90-95% of the trading volumes in the Indian Debt Markets. State Government securities & Treasury Bills account for around 3-4 % of the daily trading volumes. The trading activity in the G-Sec. Market is also very concentrated currently (in terms of liquidity of the outstanding G-Secs.) with the top 10 liquid securities accounting for around 70% of the daily volumes. Major players in the G-Secs market include commercial banks and PDs besides institutional investors like insurance companies. PDs play an important role as market makers in G-Secs market. A market maker provides firm two way quotes in the market i.e. both buy and sell executable quotes for the concerned securities. Other participants include co-operative banks, regional rural banks, mutual funds, provident and pension funds. Foreign Portfolio Investors (FPIs) are allowed to participate in the G-Secs market within the quantitative limits prescribed from time to time. Corporates also buy/ sell the G-Secs to manage their overall portfolio. Like any investment, debt securities too are exposed to various risks. The risk of default means that the issuer of the security may fail either to honour timely payment of dividends or interest committed at the time of investing, or repayment of the principal at maturity or both. The possibility of higher interest rates in the market when the money is invested and locked already at lower interest rates is what can be called interest rate risk. A fall in the interest rates and lack of opportunities to invest at desired high interest rate forcing the investor to keep the money idle until some opportunity arises is considered as reinvestment risk. The possible inability of the other party to deliver securities on purchase or funds on the completion of a sale is what counterparty risk is. If the holder of a debt security is not able to find counterparty for the desired price due to adverse price movements, such a risk is termed as price risk. IP and Asset Management – India Specific Page 45

Types of Debt and Fixed Income Instruments The Reserve Bank derives statutory powers to regulate market segments from specific provisions of the Reserve Bank of India Act, 1934. The prudential guidelines issued to eligible market participants form the broad regulatory framework for Government securities, money market and interest rate derivatives. The Government securities market, which trades securities issued by Central and State Governments, has seen significant growth in the last two decades. It has a sizeable primary and an active secondary segment. Trading largely takes place on the Negotiated Dealing SystemOrder Matching (NDS-OM), an anonymous order-matching trading platform. The average daily trading volume in Government securities market has shown significant growth from Rs.32.15 billion in 2005-06 to Rs.433.12 billion in 2014-15. All the secondary market transactions in Government Securities are settled through a central counterparty mechanism under Delivery Versus Payment mode. Multilateral netting is achieved with a single fund’s settlement obligation for each member for a particular settlement date. The settlement is achieved in the RTGS (Real Time Gross Settlement) Settlement/Current Account maintained by the member in the Reserve Bank. Uncollateralised call money market is restricted to banks and Primary Dealers subject to prudential limits. The collateralised segments include Collateralised Borrowing and Lending Facility (CBLO) and market repo transactions between banks and financial institutions. The money market also includes Commercial Paper (CP) issuances by corporates, PDs and financial institutions and Certificates of Deposit (CD) issued by banks to institutional investors. Detailed guidelines on each segment of the money market are available under the section Master Circulars for financial markets on this website. In order to ensure the robustness and credibility of the financial system and to minimise the risks, the Reserve Bank has designated industry bodies Fixed Income, Money Markets and Derivatives Association of India (FIMMDA) and Foreign Exchange Dealers Association of India (FEDAI) as the benchmark administrators for the Rupee interest rate and foreign exchange benchmarks, respectively. The FIMMDA, FEDAI and Indian Banks Association (IBA) have since jointly floated an independent company for benchmark administration. Benchmark submission activities of banks and PDs including their governance framework for submission are proposed to be brought under the Reserve Bank’s on- site and off-site supervision. While the G-Secs market generally caters to the investors with a long-term investment horizon, the money market provides investment avenues of short-term tenor. Money market transactions are IP and Asset Management – India Specific Page 46

generally used for funding the transactions in other markets including G-Secs market and meeting short term liquidity mismatches. By definition, money market is for a maximum tenor of one year. Within the one year, depending upon the tenors, money market is classified into: • Overnight market - The tenor of transactions is one working day. • Notice money market – The tenor of the transactions is from 2 days to 14 days. • Term money market – The tenor of the transactions is from 15 days to one year Call money market- is a market for uncollateralized lending and borrowing of funds. This market is predominantly overnight and is open for participation only to scheduled commercial banks and the primary dealers. Repo or ready forward contact -is an instrument for borrowing funds by selling securities with an agreement to repurchase the said securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed. The reverse of the repo transaction is called ‘reverse repo’ which is lending of funds against buying of securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the funds lent. ‘Tri-party repo'; means a repo contract where a third entity (apart from the borrower and lender), called a Tri- Party Agent, acts as an intermediary between the two parties to the repo to facilitate services like collateral selection, payment and settlement, custody and management during the life of the transaction. Funds borrowed under repo including tri-party repo in government securities shall be exempted from CRR/SLR computation and the security acquired under repo shall be eligible for SLR provided the security is primarily eligible for SLR as per the provisions of the Act under which it is required to be maintained. Commercial Paper (CP) - is an unsecured money market instrument issued in the form of a promissory note and held in a dematerialized form through any of the depositories approved by and registered with SEBI. A CP is issued in minimum denomination of ₹5 lakh and multiples thereof and shall be issued at a discount to face value No issuer shall have the issue of CP underwritten or co-accepted and options (call/put) are not permitted on a CP. Companies, including NBFCs and AIFIs, other entities like co-operative societies, government entities, trusts, limited liability partnerships and any other body corporate having presence in India with net worth of ₹100 cr or higher and any other entities specifically permitted by RBI are eligible to issue Commercial papers subject to conditions specified by RBI. All residents, and non-residents permitted to invest in CPs under Foreign Exchange Management Act (FEMA), 1999 are eligible to invest in CPs; however, no person can invest in CPs issued by related parties either in the primary or secondary market. Investment by regulated financial sector entities will be subject to such conditions as the concerned regulator may impose. IP and Asset Management – India Specific Page 47

Certificate of Deposit (CD) -is a negotiable money market instrument and issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period.Banks can issue CDs for maturities from 7 days to one year whereas eligible FIs can issue for maturities from 1 year to 3 years. Fixed Deposit (FD) is one of the most preferred investments in India among conservative investors. Whether issued by Banks or Corporates, fixed deposit or term deposit schemes offer a fixed interest rate yet, different for varying periods of maturity. Fixed deposits provide a cumulative interest option payable along with the principal at maturity or periodic interest payments on a monthly or quarterly or semi-annually or yearly basis. In comparison to bank fixed deposits, schemes offered by corporates are risky and have some default risk. Bonds-usually pay a fixed coupon rate and are issued by Governments, quasi-government institutions or corporations for a fixed tenure. A plain vanilla bond has a face value of Rs. 100 or 1000 or 10000 and pays coupon semi-annually with the return of principal at maturity. Different types of bonds exist in India. For example, the Reserve Bank of India issues taxable bonds on behalf of the Government of India with cumulative option to pay both interest and principal together at maturity or with periodic interest payments. A zero-coupon bond is issued at a discount to the face value and redeemed at par on maturity. It does not pay interest separately. For example, if the face value of a bond is Rs. 1000 and it is auctioned and issued at a discount for say, Rs. 935 for one year, it is assumed that the bond has a yield of 6.5%. Capital gains bonds are issued by approved organisations to facilitate investors save tax to a certain extent on the capital gain made as per the provisions of the Income Tax Act, 1961. Debentures-are secured debt instruments that have fixed interest rates and are collateralised against fixed assets of the issuing entity. Certain types of debentures are convertible to equity shares at maturity but presently they are uncommon in India. Non-convertible debentures (NCD) are more frequent and are comparable to any corporate fixed deposit that pays interest periodically or together with the principal at maturity. In case of cumulative option, the NCD will be subject to capital gain tax. After detailed study, one will find that most of the debt products have simple common structure with minor differences. They either pay an interest or dividend, or provide capital appreciation at maturity and except in case of exclusively tax-exempted bonds, both, income and gain are taxable as per different sections of the Income Tax Act. Trading in Various Debt Products- Prior to introduction of auctions as the method of issuance, the interest rates were administratively fixed by the Government. With the introduction of auctions, the rate of interest (coupon rate) gets fixed through a market-based price discovery process. An auction may either be yield based or price based. IP and Asset Management – India Specific Page 48

RBI has from April 22, 2019 started conducting the auction for conversion of Government of India securities on third Monday of every month. Bidding in the auction implies that the market participants agree to sell the source securities to the Government of India (GoI) and simultaneously agree to buy the destination security from the GoI at their respective quoted prices. The source securities along with notified amount and corresponding destination securities are provided in the press release issued before the auction. The market participants are required to place their bids in e-kuber giving the amount of the source security and the price of the source and destination security expressed up to two decimal places. The price of the source security quoted must be equal to the FBIL closing price of the source security as on the previous working day. The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills of 91- day, 182- day and 364-day tenors. Settlement for the T-bills auctioned is made on T+1 day i.e. on the working day following the trade day. The Reserve Bank releases a quarterly calendar of T-bill issuances for the upcoming quarter in the last week of the preceding quarter. e.g. calendar for April-June period is notified in the last week of March. The Reserve Bank of India announces the issue details of T-bills through a press release on its website every week. Like T-bills, Cash Management Bills (CMBs) are also issued at a discount and redeemed at face value on maturity. The tenor notified amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government. The tenors of CMBs is generally less than 91 days. The announcement of their auction is made by Reserve Bank of India through a Press Release on its website. The non-competitive bidding scheme has not been extended to CMBs. However, these instruments are tradable and qualify for ready forward facility. Investment in CMBs is also reckoned as an eligible investment in G-Secs by banks for SLR purpose under Section 24 of the Banking Regulation Act, 1949. The Public Debt Office (PDO) of RBI, acts as the registry and central depository for G-Secs. They may be held by investors either as physical stock or in dematerialized (demat/electronic) form. From May 20, 2002, it is mandatory for all the RBI regulated entities to hold and transact in GSecs only in dematerialized (SGL) form. There is an active secondary market in G-Secs. The securities can be bought / sold in the secondary market either through (i) Negotiated Dealing System-Order Matching (NDS-OM) (anonymous online trading) or through (ii) Over the Counter (OTC) and reported on NDS-OM or (iii) NDS-OM-Web and (iv) Stock exchanges Once the allotment process in the primary auction is finalized, the successful participants are advised of the consideration amounts that they need to pay to the Government on settlement day. The IP and Asset Management – India Specific Page 49

settlement cycle for auctions of all kind of G-Secs i.e. dated securities, T-Bills, CMBs or SDLs, is T+1, i.e. funds and securities are settled on next working day from the conclusion of the trade. On the settlement date, the fund accounts of the participants are debited by their respective consideration amounts and their securities accounts (SGL accounts) are credited with the amount of securities allotted to them. The transactions relating to G-Secs are settled through the member’s securities / current accounts maintained with the RBI. The securities and funds are settled on a net basis i.e. Delivery versus Payment System-III (DvP-III). CCIL guarantees settlement of trades on the settlement date by becoming a central counterparty (CCP) to every trade through the process of novation, i.e., it becomes seller to the buyer and buyer to the seller. All outright secondary market transactions in G-Secs are settled on a T+1 basis. However, in case of repo transactions in G-Secs, the market participants have the choice of settling the first leg on T+0 basis or T+1 basis as per their requirement. The CCIL is the clearing agency for G-Secs. It acts as a Central Counter Party (CCP) for all transactions in G-Secs by interposing itself between two counterparties. In effect, during settlement, the CCP becomes the seller to the buyer and buyer to the seller of the actual transaction. All outright trades undertaken in the OTC market and on the NDS-OM platform are cleared through the CCIL. Once CCIL receives the trade information, it works out participant-wise net obligations on both the securities and the funds leg. The payable / receivable position of the constituents (gilt account holders) is reflected against their respective custodians. CCIL forwards the settlement file containing net position of participants to the RBI where settlement takes place by simultaneous transfer of funds and securities under the ‘Delivery versus Payment’ system. CCIL also guarantees settlement of all trades in G-Secs. That means, during the settlement process, if any participant fails to provide funds/ securities, CCIL will make the same available from its own means. For this purpose, CCIL collects margins from all participants and maintains ‘Settlement Guarantee Fund’. Commodities Markets - Commodities are vital for the development and growth of any nation’s economy. Alongside stocks and bonds, trading in commodities has a significant contribution to the trade relation among countries. Billions of dollars of trade in commodities occur globally every day. Agricultural products such as pulses and cereals, metals such as gold and silver etc. are traded on the exchanges and also through derivative contracts besides the traditional physical delivery. With a variety of ways to trade, commodities are a suitable investment vehicle for diverse types of investors. Structure, Exchanges, and Regulation – Commodity derivatives exchanges shall comply with the provisions of SCRA, applicable provisions of Securities Contracts (Regulation) (Stock Exchanges and IP and Asset Management – India Specific Page 50