Challenge Pathway -Prep Book

\"...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto\" The Board consists of a Chairman, two members from amongst the officials of the Ministry of the Central Government dealing with Finance [and administration of the Companies Act, 1956], one member from amongst the officials of the Reserve Bank, and five other members of whom at least three shall be the whole-time members to be appointed by the Central Government. The general superintendence, direction and management of the affairs of the Board shall vest in a Board of members. The Chairman shall also have powers of general superintendence and direction of the affairs of the Board and may also exercise all powers and do all acts and things which may be exercised or done by that Board. Key Functions of SEBI It is the duty of the Board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. Some principal functions of SEBI are as follows. ● to regulate the business in stock exchanges and any other securities markets ● to register and regulate the working of Stockbrokers, Registrars, Depositories, Credit Rating Agencies, Foreign Institutional Investors, Mutual Funds, Underwriters, Advisers etc. and intermediaries who may be associated with securities markets in any manner ● promoting and regulating self-regulatory organisations, investors’ education, and training of intermediaries of securities markets ● prohibiting fraudulent and unfair trade practices relating to securities markets and insider trading in securities ● regulating substantial acquisition of shares and takeover of companies ● calling for information from, undertaking inspection, conducting inquiries and audits of stock exchanges, mutual funds, other persons associated with the securities market, intermediaries and self-regulatory organisations in the securities market International College of Financial Planning – Challenge Pathway Prep Book Page 147

● calling for information and records from any person including any bank or any other authority or board or corporation established or constituted by or under any Central or State Act which, in the opinion of the Board, shall be relevant to any investigation or inquiry by the Board in respect of any transaction in securities ● calling for information from, or furnishing information to, other authorities, whether in India or outside India, having functions similar to those of the Board, in the matters relating to the prevention or detection of violations in respect of securities laws ● undertake inspection of any book, or register, or other document or record of any listed public company or a public company, which intends to get its securities listed on any recognised stock exchange Money Markets Money market refers to trading in short term debt instruments, which have varying maturity periods, up to 365 days. The short-term lending and maturity provide liquidity to lenders and the financial system. It has no physical presence and transactions happen electronically. Credit instruments that vary by maturity period, risk and structure are issued by borrowers, which are usually governments, banks and other financial institutions. This segment is regulated by India’s central bank, the Reserve Bank of India. Some common money market instruments are – 1. Treasury Bill – This short-term debt instrument is auctioned by the Reserve Bank of India on behalf of the Central Government. Evidently, it is one of the safest instruments meaning, they bear no risk at all. Treasury bills are issued for varying maturities of 91 days, 182 days and 364 days. They are zero-coupon in nature i.e. they do not bear interest. Instead, they are issued at a discount to the face value and redeemed at par, on maturity. The difference between the discounted issue price and face value is the return to the investor. Since 2010, similar to T-bills, government introduced Cash Management Bills for maturity periods of less than 91 days to meet temporary mismatches in cash flows. Individuals and HUF can also invest in T-bills. International College of Financial Planning – Challenge Pathway Prep Book Page 148

2. Certificate of Deposit – It is issued by banks generally to meet their liquidity and lending requirements. They provide a fixed interest rate to the investor and have a specific maturity period. Though they are usually short-term in nature, they can be issued for up to five years, in any denomination. Compared to treasury bills, they bear higher risk and hence they offer higher interest rate. 3. Commercial Paper – Similar to certificate of deposit, CP is also comparable to a promissory note issued by large financial institutions, corporates and primary dealers, subject to the eligibility conditions specified by the central bank. They are issued for periods of less than one year. Compared to CDs, they return higher interest as they are not secured by collaterals and exposed to default risk. 4. Repurchase Agreement – Unlike T-bill, CD and CP, this is a secured, collateralised short- term borrowing agreement between two parties. Under this agreement, the borrower sells securities to the lender with an agreement and obligation to repurchase them at a specific rate and date in the future. The term reverse repo is same but from lender’s view. This must not be mistaken to RBI’s Repo and Reverse Repo rates. Repo is the rate at which banks borrow money from the RBI, and the Reverse Repo is the rate at which banks lend money to the RBI. The Securities Markets – Structure and Key players Securities and Types of Securities A ‘Security’ is a financial instrument issued primarily by a company or corporation or government to raise funds to meet various operational requirements. Depending on its nature, a security represents part ownership in a company or right to receive a compensation in the form of capital appreciation or divided or both, proportionate to the value of the security, liquidity foregone and risk inherent to it, as mutually agreed upon or practically, the conditions laid by the issuer of a security and agreed to, by the investor. Simply put, a security is a means to transfer idle or investible funds from one person who has no immediate need, to those (non-individuals such as the corporate and government) have financial International College of Financial Planning – Challenge Pathway Prep Book Page 149

needs. Those who buy securities from the issuer are generally called investors though in cases of certain type of securities, they may be lending monies to issuers of securities. Securities are broadly categorised into Equity and Debt. In investing, equity refers to equity shares of a company, whether private limited or public limited. Buying and holding equity shares implies ownership in a company, proportionate to the number of shares held against the total number of shares issued by the company and fully paid. Though return from equity generally comes in the form of appreciation of share price, some companies also pay dividends to the shareholders, out of the profits earned. On the contrary, Debt is primarily a fixed income instrument. In any debt product/security/instrument, interest is either paid out or to the investor (practically lender) or compounded for the mutually agreed term. There are a wide range of debt products in India, such as Bonds, Non-convertible Debentures (NCD), Government Securities (G-secs), Certificate of Deposit (CD), and Commercial Paper (CP) etc. Except investments like Equity, most products can fundamentally be called Debt if they involve one party receiving the money with an obligation to pay interest or dividend and the other party is lending or depositing money. Types of Securities Markets Securities markets are classified as Primary Market and Secondary Market. They are interlinked in terms of the issuance and the trading of securities. If the government or a company creates new securities, be it debt or equity and issue them for the first time to raise capital or funds, it is referred to as an issue (meaning, issuance) in the primary market. In primary market, securities are directly purchased from the entity that has created them and the funds directly go to that entity in the form of capital or borrowing. Once the securities are issued in the primary market through Initial Public Offer (IPO) or Private Placement, the subsequent action happens in, what is called as the secondary market. Suppose you purchased equity shares of a company when it first issued the shares. It has been a while and you want to sell the shares as the value appreciated and you are in profit, or you simply need money. The issuing company will have nothing to do with it. It will not buy the shares back from you. You will have to find a buyer who is interested in the securities you are holding and willing to pay the International College of Financial Planning – Challenge Pathway Prep Book Page 150

price you ask. This is what secondary market refers to. In the secondary market, securities that have already been issued are traded among investors. Secondary market provides scope for liquidity. Key Players in Securities Markets Securities markets have three broad participants – the issuers, intermediaries and the investors. Intermediaries are those parties that facilitate the process of issuing the securities by the issuers and trading in those securities by the investors, as required by the securities laws and securities market regulations laid down by the regulator, SEBI. We now know about the key players in the primary market, viz. the Issuer, The Underwriter, the Lead Manager, the Registrar and Banker to the issue. The key players in the secondary market are, the Exchange, Stockbroker & Sub-broker, Clearing Corporation, Depository & Depository Participant, etc. We shall learn more and in detail about them. The following are key investors in the securities market: 5. Retail investors & High Net-worth Individuals 6. Mutual Funds, Insurance Companies, Pension Funds etc. 7. Foreign Portfolio Investors and Domestic Institutional Investors 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. International College of Financial Planning – Challenge Pathway Prep Book Page 151

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 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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 152

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 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 International College of Financial Planning – Challenge Pathway Prep Book Page 153

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. 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. 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. International College of Financial Planning – Challenge Pathway Prep Book Page 154

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 percent. • 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. International College of Financial Planning – Challenge Pathway Prep Book Page 155

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 percent should be allotted to Qualified Institutional buyers, failing which the full subscription shall be refunded. [OR] • 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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 156

in securities. As they are a common platform that attracts a large number of individual or institutional 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 o 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. o 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. o 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 dangerous to investors and the growth of the corporate sector. Exchanges provide a well- monitored and regulated speculation by way of derivative instruments (futures and options). o 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. o Evaluation of Securities The stock exchange is useful for the evaluation of of industrial securities. This enables investors to know the true worth of their holdings at any time. Comparison of companies in the same International College of Financial Planning – Challenge Pathway Prep Book Page 157

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. o 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. o 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. o 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 settled through exchange of obligations. The clearing banks and the depositories provide the necessary International College of Financial Planning – Challenge Pathway Prep Book Page 158

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 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 pay- in 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. Many firms charge International College of Financial Planning – Challenge Pathway Prep Book Page 159

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 hold those 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. 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): • ICRA (Investment Information and Credit Rating Agency International College of Financial Planning – Challenge Pathway Prep Book Page 160

• BWR (Brickwork Ratings): • Infomerics Valuation and Rating Private (IVRP) Limited • CARE (Credit Analysis and Research limited): 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. 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 six main Credit Bureaus in India registered under SEBI, namely: • Trans Union 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 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. International College of Financial Planning – Challenge Pathway Prep Book Page 161

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 KYC compliant, 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. Major Stock Exchanges – Stock Indices – Basis and Composition 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) 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: International College of Financial Planning – Challenge Pathway Prep Book Page 162

• 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 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 is 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. 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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 163

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. Market information - Capitalization, Turnover The market capitalization of a company is in other words the market value of the company’s equity. It is an 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. Investment Landscape 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 International College of Financial Planning – Challenge Pathway Prep Book Page 164

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) account holders. 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. 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. 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. International College of Financial Planning – Challenge Pathway Prep Book Page 165

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 issue 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. 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. • 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 • 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. 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. o 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 International College of Financial Planning – Challenge Pathway Prep Book Page 166

o 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. o 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. o 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. Income/Debt 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. o 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. o 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. o 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 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. International College of Financial Planning – Challenge Pathway Prep Book Page 167

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. 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 units- Short term- 15% Long term- 10% more than Rs 1 lakh without indexation benefit. 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% International College of Financial Planning – Challenge Pathway Prep Book Page 168

(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 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 ` 0.1 million while short- term capital gains will be taxed at the rate of 15% (plus applicable surcharge and cess). 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. International College of Financial Planning – Challenge Pathway Prep Book Page 169

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. 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. International College of Financial Planning – Challenge Pathway Prep Book Page 170

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 have 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 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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 171

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. 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 give 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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 172

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.11 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 the this. Cost of carry fills the gap between the spot and future prices. At any point in time, there are always equal number of long contracts (buy) and short contracts (sell). The total number of contract (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. International College of Financial Planning – Challenge Pathway Prep Book Page 173

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 opportunities are short lived due to the trading by opportunistic arbitrageurs.in order to monetise the price differences. Futures Price = Spot Price + Cost of Carry 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 International College of Financial Planning – Challenge Pathway Prep Book Page 174

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 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. There are two primary models for calculating the value of an option viz. Binomial Pricing Model and Black-Scholes Model. William Sharpe developed the binomial pricing model. It is a convenient and preferred method of calculating option prices. The progressive growth in the price estimates of an underlying asset at regular intervals with the assumption that the price can go either way at fixed rates under any given scenario. It is more time consuming than Black-Scholes and also more accurate. Unlike the binomial model, the Black & Scholes model developed by Fisher Black and Myron Scholes calculates the option price by taking into consideration, the strike price, spot price, expiration, interest and risk. It does not consider any cash inflows in the form of dividend or other. International College of Financial Planning – Challenge Pathway Prep Book Page 175

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. 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. International College of Financial Planning – Challenge Pathway Prep Book Page 176

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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 177

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) them 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. 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 percent in the debt segment and allowing them to 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. 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 International College of Financial Planning – Challenge Pathway Prep Book Page 178

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 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. 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. 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. 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. International College of Financial Planning – Challenge Pathway Prep Book Page 179

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. Commodities Markets Commodities are vital for the development and growth of any nation’s economy. Alongside stocks and bonds, trading in commodities have 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 International College of Financial Planning – Challenge Pathway Prep Book Page 180

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 The Commodity Derivatives Exchanges have been using a ‘Spot Price Polling Mechanism’ to arrive at the prevailing spot prices. Transparent discovery of spot prices is a critical factor in smooth running of futures market as the same are used as reference prices for settlement of contracts traded on the exchange platform. To arrive at the prevailing spot prices, the exchanges are polling the spot prices from various spot price polling participants. Some exchanges undertake this activity themselves while some have outsourced this work to an external agency. Until 2015, commodity derivatives and the exchanges were regulated by the Forward Markets Commissions as per the rights and control vested in it by the Forward Contracts Act, 1952. However, after a crisis involving the National Spot Exchange, in 2015, the control of the commodities markets and exchanges was shifted to SEBI and the forward markets commission was merged with SEBI, giving the latter full control of the markets and paving way for better surveillance and regulation of the markets. There were six commodity exchanges in India viz. Multi Commodity Exchange (MCX), National Commodities and Derivatives Exchange (NCDEX), National Multi Commodity Exchange, Indian Commodity Exchange, ACE Derivatives Exchange and the Universal Commodity Exchange. However, in 2018, SEBI allowed exchanges to trade in commodity derivatives alongside stocks and laying down flexible norms for foreign investors but restricting cross-shareholding in mutual funds and credit rating agencies. This move benefited the top stock exchanges viz. BSE Ltd. (formerly the Bombay Stock Exchange Ltd.) and National Stock Exchange (NSE) to launch commodity trading. Price controls are government mandated minimum or maximum prices that can be charged for specified goods. Government sometimes implements price controls when prices on essential items, such as food grain or oil are rising rapidly. Such goods which are prone to price control may be less conducive for derivatives markets. The Food control Regulation Act, Essential commodities Act, APMC International College of Financial Planning – Challenge Pathway Prep Book Page 181

Act etc., may have an impact on the commodities to be introduced for derivatives trading. Commodities which have excessive restrictions may be less conducive for derivatives markets. Commodities which have a strong correlation with the global market have higher need for price risk management. Such commodities are conducive for derivatives trading. The Indian commodity sphere is characterized by seasonality. The prices fluctuate with the supply season and the off season. The derivatives market is necessary to even out this fluctuation and facilitate better price discovery. Thus the commodities with higher seasonality are conducive for derivatives trading. Commodities with high volatility of prices have high need for hedging. Such commodities are conducive for Derivatives trading. Commodities Futures and their Settlement Mechanism • An agricultural commodity shall be classified as a sensitive commodity if it is prone to frequent Government/External interventions. These interventions may be in the nature of stock limits, import/export restrictions or any other trade related barriers; or has observed frequent instances of price manipulation in past five years of derivatives trading • An agricultural commodity shall be classified as ‘Broad Commodity’ if it is not ‘Sensitive Commodity’ and the average deliverable supply for past five year is at least 10 lakh Metric Ton (MT) in quantitative term and is at least INR 5,000 Crore in monetary term. • An agricultural commodity which is not falling in either of the above two categories, viz ‘Sensitive’ or ‘Broad’ commodity, shall be classified as ‘Narrow Commodity’ The following norms shall be applicable to Non-Agricultural commodity derivatives at commodity level. • For calculating overall position of a client, all long and short positions of the client across all contracts shall be netted out. • Client level position limits shall be equivalent to the specified numerical level limit or 5% of market-wide open interest, whichever is higher • Member level position limits shall be 10 times of the numerical value of client level position limits or 20% of the market-wide open interest, whichever is higher International College of Financial Planning – Challenge Pathway Prep Book Page 182

Exchanges shall monitor the open position on a real time basis and shall endeavour that no client or member breaches the open position limits 'at end of the day' as well as 'during intra-day trading'. Penalty shall be levied on those breaching the position limits at end of the day as well as during intra- day trading. To facilitate larger participation by genuine hedgers by providing them with necessary incentives with a view to deepen the commodity derivatives market, the exchanges stipulate a Hedge Policy for granting hedge limits to their members and clients. Exchanges shall impose initial margins sufficient to cover its potential future exposure to participants in the interval between the last margin collection and the close out of positions following a participant default. Exchanges shall therefore estimate appropriate Margin Period of Risk (MPOR) for each product based on liquidity in the product. The margins should be computed on real time basis. The computation of portfolio initial margin would have two components. The first is the computation of initial margin for each individual contract. At the second stage, these contract initial margins would be applied to the actual portfolio positions to compute the portfolio initial margin. All open positions of a futures contract would be settled daily, only in cash, based on the Daily Settlement Price (DSP). DSP shall be reckoned and disseminated by the Exchange at the end of every trading day. The mark to market gains and losses shall be settled in cash before the start of trading on T+1 day. If mark to market obligations are not collected before start of the next day’s trading, the exchange shall collect correspondingly higher initial margin (scaling up by a factor of square root of two) to cover the potential losses over the time elapsed in the collection of margins. Daily mark to market settlement and final settlement in respect of admitted deals in futures contracts shall be cash settled by debit/ credit of the clearing accounts of clearing members with the respective clearing bank. All positions (brought forward, created during the day, closed out during the day) of a clearing member in futures contracts, at the close of trading hours on a day, shall be marked to market at the daily settlement price (for daily mark to market settlement) and settled. International College of Financial Planning – Challenge Pathway Prep Book Page 183

Foreign Exchange Markets For a long time, foreign exchange in India was treated as a controlled commodity because of its limited availability. The early stages of foreign exchange management in the country focussed on control of foreign exchange by regulating the demand due to its limited supply. Exchange control was introduced in India under the Defence of India Rules on September 3, 1939 on a temporary basis. The statutory power for exchange control was provided by the Foreign Exchange Regulation Act (FERA) of 1947, which was subsequently replaced by a more comprehensive Foreign Exchange Regulation Act, 1973. This Act empowered the Reserve Bank, and in certain cases the Central Government, to control and regulate dealings in foreign exchange payments outside India, export and import of currency notes and bullion, transfer of securities between residents and non-residents, acquisition of foreign securities, and acquisition of immovable property in and outside India, among other transactions. The Reserve Bank of India is the custodian of the country’s foreign exchange reserves and is vested with the responsibility of managing their investment. The legal provisions governing management of foreign exchange reserves are laid down in the Reserve Bank of India Act, 1934. The Reserve Bank’s reserves management function has in recent years grown both in terms of importance and sophistication for two main reasons. First, the share of foreign currency assets in the balance sheet of the Reserve Bank has substantially increased. Second, with the increased volatility in exchange and interest rates in the global market, the task of preserving the value of reserves and obtaining a reasonable return on them has become challenging. The basic parameters of the Reserve Bank’s policies for foreign exchange reserves management are safety, liquidity and returns. Structure, Functions and Regulation The Reserve Bank issues licences to banks and other institutions to act as Authorised Dealers in the foreign exchange market. In keeping with the move towards liberalisation, the Reserve Bank has undertaken substantial elimination of licensing, quantitative restrictions and other regulatory and discretionary controls. International College of Financial Planning – Challenge Pathway Prep Book Page 184

Apart from easing restrictions on foreign exchange transactions in terms of processes and procedure, the Reserve Bank has also provided the exchange facility for liberalised travel abroad for purposes, such as, conducting business, attending international conferences, undertaking technical study tours, setting up joint ventures abroad, negotiating foreign collaboration, pursuing higher studies and training, and also for medical treatment. Moreover, the Reserve Bank has permitted residents to hold liberal amount of foreign currency. Residents can now also open foreign currency accounts in India and credit specified foreign exchange receipts into it. The FEMA, 1999, provides the statutory framework for the regulation of Foreign Exchange derivatives contracts. Residents can hedge their foreign exchange exposures through various products, such as, forward contracts, options involving rupee and foreign currencies, currency swaps and cost reduction option structures in the OTC market. Foreign investors can also hedge their investments in equity and/or debt in India through forwards and options. In addition, trading within specified position limits is permitted on exchange traded currency futures in four currency pairs and in USD for currency options. Residents are also permitted to hedge their commodity price risk, as per specific guidelines, in the overseas OTC markets and exchanges. Foreign investment comes into India in various forms. Following the reforms path, the Reserve Bank has liberalised the provisions relating to such investments. The Reserve Bank has permitted foreign investment in almost all sectors, with a few exceptions. In many sectors, no prior approval from the Government or the Reserve Bank is required for non-residents investing in India. Foreign institutional investors are allowed to invest in all equity securities traded in the primary and secondary markets. Foreign institutional investors have also been permitted to invest in Government of India treasury bills and dated securities, corporate debt instruments and mutual funds. The NRIs have the flexibility of investing under the options of repatriation and non-repatriation. Similarly, Indian entities can also make investment in an overseas joint venture or in a wholly owned subsidiary abroad up to a certain limit. International College of Financial Planning – Challenge Pathway Prep Book Page 185

Indian companies are allowed to raise external commercial borrowings including commercial- bank loans, buyers’ credit, suppliers’ credit, and securitised instruments. Foreign Currency Convertible Bonds (FCCBs) and Foreign Currency Exchangeable Bonds (FCEBs) are also governed by the ECB guidelines. As a step towards further simplification and liberalisation of the foreign exchange facilities available to the residents, the Reserve Bank has permitted resident individuals to freely remit abroad up to liberal amount per financial year for any permissible purposes. Real Estate, Gold and Collectibles Real estate, precious metals such as gold, and collectibles are three other asset classes like equity, debt, commodities and currency. These too have different risk, expected return, recommended average period of holding, liquidity, marketability and taxability. Hence, before including these asset classes in the asset allocation of the financial plan and apportioning them to various financial needs and goals, they must be studied individually in detail. Forms of Realty – Land, Residential and Commercial Real Estate has been the cherry pick of Indians for ages. But the trend turned into obsession in the last half century in India. The youth, in present days, no sooner are they through with their higher education and landing up in some job, go for a housing loan and buy property. This happens either because they are too excited seeing ample money in their hands and want to accumulate wealth for themselves or sometimes, because they want to appease their parents. What everyone fails to notice is that they are not just acquiring property, but by taking a loan, they are creating a huge liability that they will carry until their middle age, for 20 years or so. And, importantly, those who encourage them to buy property do not journey with them through the years and render proper advice when the latter is striving to pay off the liability and suffering from compromised cashflows. Property bought through loan, though convenient enough, usually eats away a lion’s share of an individual’s savings potential often leaving one with meagre or no surplus at all. Since the property bought will not be used to sell off and create pension or regular income in old age, and the future growth in earnings is used to adjust towards the increasing prices and changing lifestyle and planning for other needs and goals, critical needs are usually left out, unplanned. Alternately, individuals may consider buying a piece of land in International College of Financial Planning – Challenge Pathway Prep Book Page 186

the suburban, if they can identify a scheme that allows payment in instalments. However, appreciation of such an investment takes many years and even after exhibiting such remarkable patience, non- development in the geography where the property is located will prove disheartening. Real estate or property is one asset class that needs huge capital to invest in, except when someone is borrowing but it rewards the investors handsomely in the long-term. However, there are drawbacks. Liquidity is the first hurdle in property. Suppose one has dire need for money and gets ready to sell the property, but the market is so low, and prices have drastically come down that even if the person is ready to part with it at a reduced price, finding a buyer may not be so easy. Added to that, political uncertainty, and high expenses for either of the party might prevent one from being able to sell the asset. Precious Metals - Gold Gold can be bought in the form of jewellery, coins, bars, or gold exchange traded funds, gold fund of funds or e-gold or through any scheme offered by gold shops. If Gold was purchased in Oct- 2008 and held for 5 years i.e. till Oct-2013, the return would be 14.77%. If it was bought for an average of Rs. 29600 in 2013, at the beginning of 2019, with the price being 28800, the five-year return on gold calculates to -2.60%. If the same is calculated for longer period say last 30 years i.e. 1988 to 2018, the compounded growth rate calculates to 7.68% per annum, assuming gold was bought only once in three decades i.e. 30 years ago. Globally, advisors suggest that allocation to gold be maintained at 5%-7% of the total portfolio. In any case, the maximum allocation to gold shall not exceed 10%. Physical Gold vs. Gold Funds vs. Sovereign Gold Bonds vs Gold ETFs Gold is a favourite commodity which Indians consume as well as invest into. This may be due to a natural love for this precious metal, ingrained through ages, and due to customs and ceremonies across regions where gold is exchanged as gift. An estimate has it than the gold residing in Indian homes would be to the extent of 25,000 tonnes. A specific genre of corporate has gold loans and gold monetization as their primary objective. This role is also performed by some banks in a limited way. International College of Financial Planning – Challenge Pathway Prep Book Page 187

The Government of India came out with Gold Monetization scheme in 2015 to mobilise gold held by households and institutions to facilitate its use for productive purposes and to reduce gold imports. The deposit certificates are issued by banks in equivalent of 995 fineness of gold for the certified value of physical gold ornaments tendered. Other steps to reduce the tendency of public to buy physical gold at least for long-term investment purposes are: Sovereign Gold Bonds (SGB) by the government and Gold Funds and Gold ETFs by mutual funds. SGBs are RBI issued digital units denominated in grams of gold, allowing individuals, HUFs, trusts, charitable institutions and universities to take exposure to gold. These tranches of SGB are for 8-year duration, carry in general 2.5% interest on the subscribed amount and offer gold- linked returns, tax- free if held for those 8 years to maturity/redemption. They seek to shift a part of the domestic savings that were used for the purchase of yellow metal. The SGB units are added to an individual’s demat account and can be traded in the market. On sale in the secondary market within the maturity period, the long-term capital gains come with indexation benefits, akin to debt mutual fund products. Gold ETFs also have the feature of gold-linked returns as in the SGB. But they do not carry any interest and have a definite cost structure toward management. They can be exchanged in digital form as well and have structure of taxation akin mutual fund debt products for short-term and long-term holding periods. Gold funds however are of different nature in the sense of their investment logic. The pooled money of investors in Gold Funds are invested in the stocks of gold mining companies, distribution channels, etc. on the global level. The performance of such invested stocks would vary greatly depending on dynamics of demand supply and other industry logistics, and hence the returns from Gold Funds can be not just linked to gold prices but can outperform or even underperform. The taxation is as applicable to Gold ETFs. International College of Financial Planning – Challenge Pathway Prep Book Page 188

Investing in Capital Markets and Investment Products Direct Investing A client who has fair knowledge of the products and skills required to operate in their respective markets may be equipped to make direct investment. However, mere possession of knowledge and skills may not be enough and a client may avail the services of professionals to make investments, e.g. by way of managed portfolios, mutual funds, collective investment schemes, etc. There is a sea change in the India marketplace over the last couple of decades from the days of holding and transacting in paper form (physical certificate) various investment products/avenues such as equity shares, bonds and mutual fund products. The electronic form of holding securities has done away with a unique number to identify a physical security certificate. The International Securities Identification Number (ISIN), a 12-character alphanumeric code assigned to a class or type of security by an issuer, serves for uniform identification of a security at trading and settlement. This has brought a revolution in the database management of registrars and transfer agents, which have digitized all issuances to the maximum extent, so much so that the securities market regulator SEBI mandated 31st March, 2019 as the last date after which the physical shares of listed companies would need to be necessarily dematerialized before their sale or transfer. At the very root of dematerialization of securities are two depositories, the National Securities Depository Ltd (NSDL) and the Central Depository Services India Ltd (CDSL). They in turn have depository participants (DP), being banks, securities companies, stockbrokers, non-baking finance companies, registrar and transfer agents, etc. The DPs hold investor accounts in electronic form and maintain investor holdings for securities purchased and kept in such accounts. They also release securities sold by investors and collect the proceeds from clearing house to credit the investors’ registered bank accounts. Price-monitoring, Price Bands and Circuit Breakers The function of a proper price monitoring mechanism is to detect potential market abuses at a nascent stage to reduce the ability of the market participants to unduly influence the price of the Securities International College of Financial Planning – Challenge Pathway Prep Book Page 189

traded at BSE by taking surveillance actions like reduction of circuit filters, imposition of special margin, transferring Securities on a trade-to-trade settlement basis, suspension of Securities/ members, etc. These proactive measures are taken based on the analysis/ processing of alerts generated based on various parameters and other inputs like news, company results, etc. The NSE and BSE have set price bands for all securities and serve as boundaries for the stock's trading; the exchange will not accept orders that are set outside the minimum and the maximum of the price range. The purpose behind price bands and circuit breakers is to control mass buying or selling of shares and send a market spiralling into one direction, and perhaps most importantly, to curb panic selling. Most stocks on the NSE and the BSE have an upper and lower price band. There are 5 categories of price bands: • If a stock has derivative products listed or if the stock is included on an index on which derivative products are available, it does not have an upper or lower price band. • A stock can have price bands of 20% either way, based on the previous day's closing price. • A stock can have price bands at 10% either way, based on the previous day's closing price. • A stock can have price bands at 5% either way, based on the previous day's closing price. • A stock can have price bands at 2% either way, based on the previous day's closing price. Similarly, a marked wide \"price band\" is implemented through the circuit breaker system. On the BSE, the Sensex is used while on the NSE, the Nifty. Whenever either triggers a circuit breaker, a coordinated trading halt is applied to all equity and derivative markets nationwide. Mutual Funds Net Asset Value and Investment Options The net asset value (NAV) is the performance barometer of a mutual fund scheme. In the new fund offering (NFO) a scheme offers units at par, generally at Rs. 10 per unit. Based on income and dividend received on invested securities, the capital appreciation thereon, and realized gains on churning International College of Financial Planning – Challenge Pathway Prep Book Page 190

investment, the value of assets in a scheme is likely to go up in due course. Per unit value of these assets across all created units in a scheme, as reduced by accrued administrative expenses and fund management fees, gives the NAV of the scheme. This NAV may not always move up. The market forces may erode partially the value of securities invested in a scheme, thereby depressing NAV from the levels at which a unitholder had invested earlier. There are open-ended schemes of a mutual fund which offer fresh investments and redemption on an ongoing basis. They do not have a fixed tenure, and are perpetual in nature. The closed- end funds generally do not take fresh investments after the initial offer, and they have a lock-in for redemptions, known as the tenure of the scheme. Interval funds are a combination of the above, in that, they have open periods at pre-fixed intervals during which redemptions, or even fresh sales are allowed. Each scheme has a dividend option and a growth option. The dividends are declared and distributed as per the dividend policy to unitholders exercising the ‘dividend’ option. On choosing a dividend reinvestment option (instead of dividend distribution option), the unitholder gets the dividend invested at the ex-dividend NAV of the scheme, and fresh units get allotted. The NAV of dividend option of the scheme reduces to the extent of dividend distributed (including taxes on dividend) per unit. In ‘growth’ option, the dividend is not declared, and the invested funds aim at compounding and long-term capital appreciation. A unitholder may exercise option to buy units in a scheme directly from a mutual fund house, in a ‘direct’ plan. The other plan is ‘regular’ in which the commissions to mutual fund distributors is dispensed by schemes in all years of a unitholder remaining invested in the scheme. The NAV of ‘direct’ plan is higher than ‘regular’ plan due to this impact of commission or sales charge. The systematic investment plan (SIP) allows a unitholder to invest regularly on monthly/ quarterly rests as per convenience of income or investable funds. The investment mandate once exercised works on auto-mode with pre-determined amount of SIP deducted at defined dates of the chosen period, and invested at that date’s NAV. The best advantage of SIP investment is a disciplined approach to investments irrespective of market level or trend. It helps in Rupee Cost Averaging, which allow more units allotted for fixed investment in depressed markets and lower number of units purchased at high NAVs during bullish phase. It allows small size investments over long periods to ride out volatility and to give a power of compounding to the invested kitty. It is the best investment strategy to save for International College of Financial Planning – Challenge Pathway Prep Book Page 191

one’s retirement, especially in the absence of access to statutory retirement plans. The systematic withdrawal plan (SWP) allows the accumulated funds to be withdrawn in fixed amounts or fixed units over a period. It allows advantages of capital gains, especially due to indexed cost of capital taken into account in debt schemes for terms of investments longer than three years. It also permits withdrawal near a goal in meeting staggered expenses as well as in riding out high volatility or a steep fall in equity on reaching a goal term. The systematic transfer plan (STP) allows periodic redemption from one scheme, equity or debt or liquid/money market, with simultaneous investment in another scheme of the same mutual fund house. This is good strategy while changing asset allocation and in rebalancing asset classes. Mutual Fund Products Mutual fund schemes have broad categorization in equity, debt, hybrid and liquid/money market. The equity and equity-oriented schemes have a minimum of 65% assets invested in equity shares of Indian companies. Many hybrid funds keep this allocation to have equity categorization. The arbitrage funds as a rule keep this exposure to equity for offering tax advantage to its unitholders, while they generate returns which are, more or less, that of debt funds. The strategy adopted by arbitrage funds is to take advantage of mispricing or price differences of equity shares in the spot and futures market. Time, Value and Event-based Triggers in MF investing Investments are meant for a long and adequate horizon. They are not meant for perpetuity unless meant for succession. They should be liquidated are at the appropriate time. Some of such appropriate times are decided by the triggers for exit. Exit triggers could be routine or pre-set, review based, ad-hoc or event based. A pre-set trigger is a finite event, in the sense that the variable and the level of the variable is decided either initially or some time into the investment. It is not a subjective decision point for the investor or the adviser, as the decision has been taken earlier, based on an objective parameter. International College of Financial Planning – Challenge Pathway Prep Book Page 192

A review-based trigger is one that comes out in the course of the discussion on a portfolio review between the investor and the financial planner. There may be a change in the objectives of the investor, in the fundamentals of the investment, sustained under-performance, or there may be a better or more suitable investment which can be availed of by switching out from an existing investment. Ad-hoc or event-based triggers reflect the uncertainties or volatilities of the market. While some volatility or noise keeps on happening every day, when there is a significant event, either positive or negative, it may require an exit if that serves the portfolio better. Direct and Regular Plans - Investment Advisor’s Role Concept of Direct and Regular Plans In a Circular dated 13 September 2012, SEBI stated that mutual funds/AMCs shall provide a separate plan for direct investments, i.e., investments not routed through a distributor, in existing as well as new schemes. Such separate plan shall have a lower expense ratio excluding distribution expenses, commission, etc., and no commission shall be paid from such plans. The plan shall also have a separate NAV. Thus, applicable since 1 January 2013, every MF Scheme has two sets of NAVs, one for direct plan and one for regular plan. The expenses of the direct plan are lower, to the extent of distribution commission paid in that scheme. Distribution mode for Investment Advisers In this context, it is important to bifurcate between advisors and distributors. An “adviser” is a SEBI registered investment adviser (RIA) and a “distributor” is a AMFI registered mutual fund distributor (MFD). An RIA can only advise his/her client and not offer execution of the investments. In exchange for the advice, the adviser is supposed to charge fees to the client, and not receive any commission from the product manufacturer. A distributor is not supposed to offer “advice” to the client, apart from some “incidental advice” and not supposed to charge fees to the client. The MFD gets commission from the Mutual Fund products distributed. International College of Financial Planning – Challenge Pathway Prep Book Page 193

Relevance of direct and regular plans • Investors taking advice from an RIA should invest in direct plans of mutual funds to benefit from lower expense ratio. In other words, the benefit of lower expense ratio is shared, in part or full, with the RIA as fees. • However, nothing stops the investor from investing in regular plans of MFs, at the cost of higher expense ratio, if s/he wants to avail of the execution from an MFD, and tracking services. • DIY investors invest straight into direct plans, without availing of RIA’s services, and save on both. • Investors going through an MFD invest in regular plans of MFs and the MF shares the distribution commission with the MFD, which is part of the expense ratio. The client is not supposed to pay any advisory fees over and above this to the MFD. Regulatory backdrop The amendment dated 3 July 2020 to the SEBI Investment Adviser Regulations allows “client level segregation of advisory and distribution activities”. It states that • An individual investment adviser shall not provide distribution services • The family of an individual investment adviser shall not provide distribution services to the client advised by the individual investment adviser and no individual investment adviser shall provide advice to a client who is receiving distribution services from other family members • A non-individual investment adviser shall have client level segregation at group level for investment advisory and distribution services. • The same client cannot be offered both advisory and distribution services within the group of the non-individual entity. Portfolio Management Schemes SEBI in their Portfolio Manager Regulations, 2020 defines a portfolio manager as being a body corporate, whether as a discretionary portfolio manager or otherwise, advises or directs or undertakes on behalf of the client the management or administration of a portfolio of securities or goods or funds of the client, as the case may be. This arrangement is strictly pursuant to a contract with a client. International College of Financial Planning – Challenge Pathway Prep Book Page 194

SEBI in the said regulations prescribe that a portfolio manager, a body corporate besides meeting a fit and proper person and other due diligence norms should have the necessary infrastructure and manpower to effectively conduct its activities as a portfolio manager. It must have the following officials with the necessary eligibility criteria: a) A Principal Officer appointed shall be responsible for the decisions made toward management or administration of the portfolio of securities or the funds of the client apart from other operations of the portfolio manager. The principal officer shall have a requisite professional qualification in finance, law, accountancy or business management or a CFA charter from the Chartered Financial Analyst Institute, USA. Experience of at least five years is also necessitated in related activities in the securities market, e.g. as a portfolio manager, a fund manager, an investment adviser, a research analyst, a stock broker, etc. At least two years out of these must be spent in funds management, portfolio management or investment advisory services. The principal officer must have, at all times, a valid relevant NISM certification as specified by SEBI in this regard. b) A Compliance Officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions, etc., issued by SEBI or the Central Government and for redressal of investors' grievances. c) At least one another person with the qualifications of graduation from a recognized Indian or foreign institution and with an experience of at least two years in the securities market preferably with a fund manager, a portfolio manager, an investment adviser, or a stock broker. The net worth requirement for a portfolio manager is at least Rs 5 crore. PMS - Direct Access vs Regular plans, optimization by Investment Advisers through direct access The portfolio manager provides services across the following three areas: International College of Financial Planning – Challenge Pathway Prep Book Page 195

(i) Discretionary services – where the portfolio manager manages the portfolio and funds of each individual client independently according to the client’s needs; (ii) Non-discretionary services – where the portfolio manager manages the portfolio and funds of each individual in accordance with the directions of the client; and (iii) Advisory services – where the portfolio manager advises the client on investments as per the agreement. A portfolio manager can be an entity who is so registered to provide portfolio management services in accordance with the Regulations. The eligible fund managers may act as a portfolio manager to an eligible investment fund by fulfilling certain conditions and applying to SEBI under the Regulations. As the third category above suggests, SEBI Registered Investment Advisers (RIA) can also provide only advisory services on investments and portfolio of securities of a client. It has been respectively laid down in the SEBI (Portfolio Managers) Regulations, 2020 and SEBI (Investment Advisers) Regulations, 2013, as amended, that such entities will provide distribution services in mutual fund units by using “Direct Plans” instead of regular plans. They may also use other non-commission products while providing distribution services along with advisory services. The logic stands that portfolio manager provides services with a minimum ticket size of Rs 50 lakh. There is no limit at the higher end. Large transactions therefore would entail a substantial amount of commission, upfront and trail, on the portfolio assets. Therefore, adoption of direct plans by investment advisers would help their clients in the efficient execution services as well while saving large costs over a period of time on the commissions, anywhere between a few basis points up to 2 per cent. Distressed Securities Distressed securities are the securities issued by a certain company which the company is finding difficult to services, viz. paying the due interest on the obligation and/or the return of capital borrowed. A market disruption or adverse macroeconomic conditions, locally or globally, may impact the credit profile of a distressed entity. It may happen as well that the situation has got nothing to with market conditions. Usually these are companies that are companies close to bankruptcy. These companies need a lifeline to revive. International College of Financial Planning – Challenge Pathway Prep Book Page 196