Investment planning

INVESTMENT PLANNING \"Approved courseware for the Certified Financial PlannerCM certification education programme in India\" Published by 'International College of Financial Planning Ltd.'

Investment Planning \"Every effort has been made to avoid any errors or omission in this book. Inspite of this errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice, which, shall be taken care of in the next printing. It is notified that neither the publisher nor the author or seller will be responsible for any damage or loss of action to anyone of any kind, in any manner, there from. No part of this book may be reproduced or copied in any form or by any means or reproduced on any disc, tape, perforated media or other information storage device, etc. without the written permission of the publisher. Breach of this condition is liable for legal action. All disputes are subject to Delhi jurisdiction only.\" ISBN 978-81-901956-0-7 (Volume–3) Revised and Reprinted in 2019

Investment Planning Published by the International College of Financial Planning Ltd. © International College of Financial Planning Limited 2003 This subject material is issued by the International College of Financial Planning Ltd. on the understanding that: 1. International College of Financial Planning Ltd., its directors, author(s), or any other persons involved in the preparation of this publication expressly disclaim all and any contractual, tortuous, or other form of liability to any person (purchaser of this publication or not) in respect of the publication and any consequences arising from its use, including any omission made, by any person in reliance upon the whole or any part of the contents of this publication. 2. The International College of Financial Planning Ltd. expressly disclaims all and any liability to any person in respect of anything and of the consequences of anything done or omitted to be done by any such person in reliance, whether whole or partial, upon the whole or any part of the contents of this subject material. 3. No person should act on the basis of the material contained in the publication without considering and taking professional advice. 4. No correspondence will be entered into in relation to this publication by the distributors, publisher, editor(s)or author(s) or any other person on their behalf or otherwise. Author Sanjiv Bajaj CFPCM, MBA (Finance), International Certificate for Financial Advisors (CII – London) Revised By: Manya Kakkar, AFP, under the guidance of Madhu Sinha CFPCM, CIWM Author (Financial Planning A Ready Reckoner and Retirement Planning A Guide for Financial Planners) Campus Director, Former, FPSB India \"Unless otherwise stated, copyright and all intellectual property rights in all course material(s) provided, is the property of the College. Any copying, duplication of the course material either directly, and or indirectly for use other than for the purpose provided shall tantamount to infringement and shall be strongly defended and pursued, to the fullest extent permitted by law.\"



CONTENTS SECTION–I: INVESTMENT PRODUCTS UNIVERSE AND THEIR APPLICATIONS 1– 88 1.1. Fixed Income Instruments 3-16 1.1.1. Government Securities 3 1.1.2. Corporate Bonds, PSU Bonds and Debentures 5 1.1.3. Term Deposits 6 1.1.4. Small Saving Schemes 8 1.1.5. Money Market Instruments 12 1.1.6. Suitability of Regular Income Generation from Investment Portfolio 14 15 Summary 1.2. Mutual Fund Products 17- 30 1.2.1. Money Market Mutual Funds (MMMFs) and Liquid Fund Schemes 17 1.2.2. Debts Funds, Gilt Fund, Fixed Maturity Plan (FMP) etc. 18 1.2.3. Equity Fund 19 1.2.4. Hybrid Funds/Balanced Mutual Fund Schemes and Monthly Income Plans (MIPs) 22 1.2.5. Exchange Traded Funds (ETFs) 23 1.2.6. Gold ETFs and Other Commodity ETFs 24 1.2.7. Funds Investing in Overseas Securities and Arbitrage Funds 24 1.2.8. Distribution and Sales Practices of Mutual Fund Schemes 25 Summary 29 1.3. Equity Market 31- 55 1.3.1. Major Stock Exchange Indices 31 1.3.2. Concept of Investing in Equity Shares 32 1.3.3. Equity Shares 34 1.3.4. Stock Trading 36 1.3.5. Market Performance Analysis and Technical Analysis of Indices 38 1.3.6. Stocks 44 1.3.7. Portfolio Management Scheme (PMS) 50 1.3.8. Market Correction 50

1.3.9. Understanding Earnings Growth Cycle 52 1.3.10. Understanding Capital Cycle 52 1.3.11. Understanding Secular Bull and Bear Cycles 53 55 Summary 1.4. Derivatives Features of Derivatives 56- 65 1.4.1. Essential Feature of Derivatives 56 1.4.2. Futures and Options 58 1.4.3. Commodity Investments 60 1.4.4. e-Gold, e-silver, etc. 62 65 Summary 1.5. Foreign Exchange Market 66- 72 1.5.1. Functions of the Foreign Exchange Market and Participants 66 1.5.2. Determinants of Exchange Rates 67 1.5.3. Speculative and Hedging Instruments 69 72 Summary 1.6. Real Estate and Other Investments 73- 88 1.6.1. Forms of Real Estate 73 1.6.2. Interplay of Cost of Credit, Rentals and Tax Benefits on Realty Investments 74 1.6.3. Ways to Gains Long-term Capital Appreciation and Steady Income Steam 76 1.6.4. REITs and REMFs 78 1.6.5. Art and Antiques 80 1.6.6. VCF and VCF 81 1.6.7. Structures Products 82 84 Summary SECTION–II: RISK PROFILING OF PRODUCTS AND INVESTORS-ASSETS ALLOCATION DETERMINATION 89- 142 2.1. Fixed Income Instruments 91- 97 2.1.1. Market Risk 91 2.1.2. Inflation Risk 92

2.1.3. Interest Rate Risk 93 2.1.4. Purchasing Power Risk 93 2.1.5. Liquidity Risk 94 2.1.6. Reinvestment Risk 94 2.1.7. Exchange Rate Risk 94 2.1.8. Regulatory Risk 95 2.1.9. Investment Manager (Alpha) Risk 95 2.1.10. Business Risk 96 97 Summary 98- 108 2.2. Product Profiling in Terms of Inherent Risk Tensure 98 2.2.1. Short-Term Products 101 2.2.2. Medium-Term Products 104 2.2.3. Long-Term Products 109- 116 2.3. Risk Profiling of Investors 109 2.3.1. Understanding Investor’s Investment Psychology and Investment Behavior 111 2.3.2. Risk on Investor’s Life Stage 111 2.3.3. Risk Based on Investor’s Earnings, Income Generation and Assets 113 2.3.4. Risk Tolerance 115 2.3.5. Classifying Investor as Per their Risk Profile 115 2.3.6. Matching Products to Investor’s Profile and Tensure of Goals 117-125 2.4. Asset Allocation – Financial Assets 117 2.4.1. Asset Allocation 117 2.4.2. Asset Classes 119 2.4.3. Expected Rate of Return 121 2.4.4. Goal Specific Asset Allocation 122 2.4.5. Asset Allocation Changes when Approaching Goals 123 2.4.6. Selection of Asset Mix According to Client’s Goals 126- 142 2.5. Types of Asset Allocation Strategies 126 2.5.1. Strategic Asset Allocation

2.5.2. Tactical Asset Allocation 128 2.5.3. Life Stage Based Asset Allocation 130 138 Summary SECTION–III: GOAL-BASED INVESTMENT PLANNING, MEASURING AND MANAGING RISK, ANALYSIS OF RETURNS 143- 236 3.1. Investment Planning to Achieve Financial Goals 145- 155 3.1.1. Goal Specific Investment Portfolio vs. Common Investment Pool 145 3.1.2. Selection of Products and Product Diversification 146 3.1.3. Additional Lump Sum Investment vs Systematic Staggered Investments 149 3.1.4. Monitoring Progress in Investment Portfolio for Goal Achievement 152 3.1.5. Addressing Risk Aversion 153 3.1.6 Avoiding Speculation 154 3.1.7. Protecting Portfolio Erosion 155 3.2. Measuring Risk 156- 177 3.2.1. Expected Returns from a Goal Portfolio 156 3.2.2. Beta and Portfolio Beta 162 3.2.3. Variance, Semi-variance and Covariance 163 3.2.4. Standard Deviation Including Standard Deviation of Portfolio 163 3.2.5. Correlation and Correlation Coefficient 170 3.3. Diversification Strategies 178- 191 3.3.1. Types of Diversification 179 3.3.2. Diversifiable / Unsystematic and Non-diversifiable/ Systematic Market Risk 180 3.3.3. Nature of Products used for Diversification 189 3.3.4. Time Diversification 189 3.3.5. Effect of Diversification on Portfolio Risk and Return 191 3.3.6. Hedging 191 3.4. Analysis of Returns 192- 236 3.4.1. Power of Compounding 193 3.4.2. Time Weighted Return vs. Money Weighted Return 195

3.4.3. Real (Inflection Adjusted) vs. Nominal Rate of Return 197 3.4.4. Effective vs Nominal Rate of Return 199 3.4.5. Total Return / Holding Period Return (HPR) 201 3.4.6. Compounded Annual Growth Rate (CAGR) and Internal Rate Return (IRR) 203 3.4.7. Yield to Maturity (YTM), Yield to Call and Current Yield 205 3.4.8. Performance Analysis of Stocks 223 3.4.9. Market Valuation Ratios 223 3.4.10. Market P/E Ratios 224 3.4.11. Security Valuation 227 3.4.12. Analysis of Growth, Dividend Payout and Reinvestment Options (MF Schemes) 231 3.4.13. Measurement and Evaluation of Portfolio Performance 232 SECTION–IV: INVESTMENT STRATEGIES AND PORTFOLIO MANAGEMENT 237- 338 4.1. Active Investment Strategies 239- 294 4.1.1. Dynamic Management of Asset Allocation Across Classes 240 4.1.2. Frequent Churning of Portfolio to Book Profits/Losses 247 4.1.3. Hunting for Gains from Investing in Temporarily Undervalued Sectors/Stocks 248 4.1.4. Speculation, Hedging and Arbitrage Strategies 249 4.1.5. Options and Futures 252 4.1.6. Market Timing 292 4.1.7. Securities Selection 293 4.1.8. Investment Style – Value vs. Growth 294 4.2. Passive Investment Strategies 295- 302 4.2.1. Buy and Hold Strategy 296 4.2.2. Index Investing 296 4.2.3. Systematic Investment Plan (SIP), Systematic Withdrawal Plan (SWP) and Systematic Transfer Plan (STP) 298 4.2.4. Value Averaging Investment Plan (VIP) 301 4.3. Investment Portfolio Management 303- 325 4.3.1. Relationship Between Risk and Return 304 4.3.2. Risk and Return on a Portfolio 307

4.3.3. Capital Asset Pricing Module (CAPM) 312 4.3.4. Capital Market Line (CML) and Security Market Line (SML) 314 4.3.5. Modern Portfolio Theory (MPT) 318 4.3.6 Monte Carlo Simulation for Portfolio Optimization 324 4.4. Revision of Portfolio 326- 335 4.4.1. Benefits of Revision 327 4.4.2. Periodic Review and Revision of Portfolio 328 4.4.3. Portfolio Rebalancing 328 4.4.4. Buy and Hold Policy, Constant Mix Policy and Portfolio Insurance Policy 329 4.4.5. Portfolio Upgrading 335 SECTION–V: REGULATORY ASPECTS – INVESTMENT PRODUCTS AND INVESTMENT ADVISORY 337- 461 5.1. Regulatory Oversight of Financial Products and Services 341- 360 5.1.1. Resave Bank of India (RBI) Act-1934 340 5.1.2. Securities and Exchange Board of India (SEBI) Act-1992 344 5.1.3. Securities Contract Regulation (SCR) Act-1956 345 5.1.4. Foreign Exchange Management Act-1999 348 5.1.5. Disclosure and Investor Protection Guideline Issued by SEBI 349 5.1.6. Grievance Mechanisms, SEBI Ombudsman Regulations-2003 352 5.1.7. Right to Information (RTI) Act-2005 353 5.1.8. Forward Contacts (Regulation) Act-1952 355 5.1.9. SEBI Investment Advisers Regulation, 2013 357

SECTION–I INVESTMENT PRODUCTS UNIVERSE and THEIR APPLICATIONS SUB-SECTIONS 1.1 Fixed Income Instruments 1.2 Mutual Fund Products 1.3 Equity Market 1.4 Derivatives and Commodities 1.5 Foreign Exchange Market 1.6 Real Estate and other Investments

Learning Objectives At the completion of this unit, students will be able to:  Describe the features of various types of fixed income instruments and determine the suitability of regular income generating investment portfolios.  Explain the various types of mutual fund schemes available for investments and their characteristics.  Understand the concept of investing in equity shares, types of equity shares and concepts related to equity markets  Evaluate the methods of analyzing the stocks using fundamental and technical analysis.  Describe the basic features of derivatives and commodities.  Explain the functioning of derivatives, commodities and foreign exchange market.  Understand how investment products such as real estate and various types of alternate investments can help in long term wealth creation and income generation. 2

Sub-Section 1.1 Fixed Income Instruments 1.1.1. Government Securities - Fixed and Variable Coupon Rates, Zero Coupon Bonds Government securities means securities created and issued by the Government for the purpose of raising a public loan or for any other purpose as may be notified by the Government in the Official Gazette. Government securities carry practically no risk of default and, hence, are called risk-free gilt-edged instruments. These are sovereign (credit risk-free) coupon bearing instruments which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government's market borrowing programme. Features of Government Securities  Issued at face value  No default risk as the securities carry sovereign guarantee.  Ample liquidity as the investor can sell the security in the secondary market  Interest payment on a half yearly basis on face value  No tax deducted at source  Can be held in Demat form.  Rate of interest and tenor of the security is fixed at the time of issuance and is not subject to change (unless intrinsic to the security like FRBs - Floating Rate Bonds).  Redeemed at face value on maturity  Maturity ranges from of 2-30 years.  Securities qualify as SLR (Statutory Liquidity Ratio) investments (unless otherwise stated). Government securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). Since the date of maturity is specified in the securities, these are known as dated Government Securities, e.g. 6.65% GS 2020 is a Central Government Security maturing in 2020, which carries a coupon of 6.65% payable half yearly. The nomenclature of a typical dated fixed coupon Government security contains the following features - coupon, name of the issuer, maturity and face value. For example, 7.26% GS 2017 would mean: Coupon 7.26% paid on face value Name of Issuer Government of India Date of Issue October 7, 2019 3

Maturity January 7, 2029 Coupon Payment Dates Half-yearly (October 07 and April 07) every year Minimum Amount of issue/ sale ₹10,000 Dated Government securities are long term securities and carry a fixed or floating coupon (interest rate) which is paid on the face value, payable at fixed time periods (usually half- yearly). The tenor of dated securities can be up to 30 years. Instruments issued are discussed below: 1. Fixed Rate Bonds – These are bonds on which the coupon rate is fixed for the entire life of the bond. Most Government bonds are issued as fixed rate bonds. For example – 8.24%GS2018 was issued on April 22, 2008 for a tenor of 10 years maturing on April 22, 2018. Coupon on this security will be paid half-yearly at 4.12% (half yearly payment being the half of the annual coupon of 8.24%) of the face value on October 22 and April 22 of each year. 2. Floating Rate Bonds – Floating Rate Bonds are securities which do not have a fixed coupon rate. The coupon is re-set at pre-announced intervals (say, every six months or one year) by adding a spread over a base rate. In the case of most floating rate bonds issued by the Government of India so far, the base rate is the weighted average cut-off yield of the last three 364- day Treasury Bill auctions preceding the coupon re-set date and the spread is decided through the auction. Floating Rate Bonds were first issued in September 1995 in India. For example, a Floating Rate Bond was issued on July 2, 2005 for a tenor of 15 years, thus maturing on July 2, 2020. The base rate on the bond for the coupon payments was fixed at 6.50% being the weighted average rate of implicit yield on 364-day Treasury Bills during the preceding six auctions. In the bond auction, a cut-off spread (markup over the benchmark rate) of 34 basis points (0.34%) was decided. Hence the coupon for the first six months was fixed at 6.84%. 3. Zero Coupon Bonds – Zero coupon bonds are bonds with no coupon payments. They are issued at a discount to the face value. Deep discount bonds, also known as zero- coupon bonds, are bonds wherein there is no interest or coupon payment and the interest amount is factored in the maturity value. So, the issue price of these bonds is inversely related to their maturity period. These were issued first on January 19, 1994 and were followed by two subsequent issues in 1994-95 and 1995-96 respectively. The key features of these securities are:  They are issued at a discount to the face value.  The tenor of the security is fixed.  The securities do not carry any coupon or interest rate. The difference between the issue price (discounted price) and face value is the return on this security.  The security is redeemed at par (face value) on its maturity date. 4

1.1.2. Corporate Bonds, PSU Bonds and Debentures Corporate Bonds Corporate bonds are debt instruments issued by private and public sector companies. They are issued for tenors ranging from 2 years to 15 years. The more popular tenors are 5-year and 7-year bonds. Most corporate bonds are issued to institutional investors such as mutual funds, insurance companies, and provident funds through private placement. Sometimes, there is a public issue of bonds where retail investors are called upon to invest. Publicly issued bonds tend to have a face value of ₹10,000. Bonds of all non-government issuers come under the regulatory purview of SEBI. They have to be compulsorily credit-rated and issued in the demat form. The coupon interest depends on the credit rating. Bonds with the highest credit rating of AAA, for example, are considered to have the highest level of safety with respect to repayment of principal and periodic interest. Such bonds tend to pay a lower rate of interest than those that have a lower credit rating such as BBB. Bonds issued by companies in the financial sector tend to carry a higher coupon interest rate, compared to those issued by companies in the manufacturing sector. This is also due to the perception of higher risk, as companies in the finance sector tend to borrow more (as a proportion of their equity capital) compared to companies in the manufacturing sector. Corporate bonds can be issued using various cash flow structures. A plain vanilla bond will have a fixed term to maturity with coupon being paid at pre-defined periods and the principal amount is repaid on maturity. The bond is usually issued at its face value, say, ₹100 and redeemed at par, the same ₹100. The simple variations to this structure could be a slightly varied issue price, higher or lower than par and a slightly altered redemption price, higher or lower than par. In some cases, the frequency of the interest payment could vary, from monthly, to quarterly and annual. Apart from a regular fixed-interest-paying bond, the other types of bonds issued are: zero coupon bonds, floating rate bonds and bonds with put or call options. Convertible bonds, allow investors to convert the bond fully or partly into equity shares, in a pre-determined proportion. Corporate bonds offered to retail investors tend to feature various options, to make it attractive to investors across tenors and frequency of interest payments. Secondary market trading is usually concentrated among institutional investors and the market is not very liquid for retail investors. Apart from credit risk, retail investors also bear liquidity risk while buying these bonds. Interest is fully taxable. PSU Bonds These are Medium or long term debt instruments issued by Public Sector Undertakings (PSUs). The term usually denotes bonds issued by the central PSUs (i.e. PSUs funded by and under the administrative control of the Government of India). Most of the PSU Bonds are sold on private placement basis to the targeted investors at market determined interest rates. PSU Bonds are issued in demat form. In order to attract the investors and increase liquidity, issuers get their bonds rated by rating agencies like CRISIL, ICRA, CARE, etc. Some of the issues may be guaranteed by Central / State Government enabling them to get a better rating. All PSU bonds have a built in redemption and some of them are embedded 5

with put or call options. Many of these are issued by infrastructure related companies such as railways and power companies and their sizes vary widely from ₹10-1000 crore. PSU bonds have maturities ranging between five and ten years. They are issued in denominations of ₹1,000 each. Public sector companies can also issue such tax-free bonds, the proceeds of which are invested in infrastructure projects. Retail individual investors, qualified institutional buyers, corporates and high net worth investors can invest in tax-free bonds in varying proportions. Tax-free bonds of PSUs are an ideal instrument for risk-averse retail investors. Under these bonds, while the investor doesn‘t get any exemption under Section 80C of the Income-Tax Act, 1961, the interest accrued is completely tax-free under Section 10(15)(iv)(h). Not having to pay tax on the interest earned on such bonds makes those more attractive than other taxable debt instruments like bank FDs. Tax-free bonds are an attractive long-term investment. There is no deduction of tax at source from the interest that accrues to bondholders, irrespective of the interest amount or status of the investor. These bonds score over bank fixed deposits on account of tax exemption on the interest earned. However, bank fixed deposits are more liquid than tax-free bonds as the latter have a longer maturity period and are not easy to sell in the secondary market. But again, tax-free bonds issued by companies are backed by the government and, so, the credit risk or risk of non-repayment is very low. Interest on these bonds is paid annually and credited directly to the bank account of the investor. The annual interest payout is good option, especially for those who are want regular income post-retirement. Debentures A debenture is an instrument of debt executed by the company acknowledging its obligation to repay the sum at a specified rate and also carrying an interest. It is one of the methods of raising the loan capital of the company. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Generally, in the Indian context, the word debenture and bonds are used interchangeably. A debenture is a debt instrument which is not backed by any specific security; instead the credit of the company issuing the same is the underlying security. Corporate treasury use this as a tool to raise medium- to long-term funds. The funds raised become part of the capital structure but not share capital of the company. Bonds, however, in India are typically issued by financial institutions, government undertakings and large companies. The interest rate is assured and is paid at a fixed interval, i.e. on an annual or semi-annual basis. On maturity, the principal is repaid. 1.1.3. Term Deposits - Bank, Post Office and Corporate Deposits A good portion of the financial assets of individual investors is held in the form of deposits like bank deposits, post office deposits, and company deposits. A distinguishing feature of these assets is that they represent personal transactions between the investor and the issuer. For example, when you open savings bank account at a bank, 6

you deal with the bank personally. In contrast, when you buy equity shares in the stock market, the buyer and seller normally do not know each other. The important types of deposits held by investors are briefly described below: Fig. Types of Deposits I. Bank Deposits: Perhaps the simplest of investment avenues, by opening a bank account and depositing money in it one can make a bank deposit. There are various kinds of bank accounts: current account, savings account, and fixed deposit account. While a deposit in a current account does not earn any interest, deposits in other kinds of bank accounts earn interest. The important features of bank deposits are as follows:  Deposits in scheduled banks are very safe because of the regulations of the Reserve Bank of India and the guarantee provided by the Deposit Insurance Corporation, which guarantees deposits upto ₹100,000 per depositor of a bank.  The interest rate on fixed deposits varies with the term of the deposit. Interest is generally paid quarterly.  Bank deposits enjoy exceptionally high liquidity. Banks now offer customers the facility of premature withdrawals of a portion or whole of fixed deposits. Such withdrawals would earn interest rates corresponding to the periods for which they are deposited, at times with some penalty.  Loans can be raised against bank deposits.  A tax savings fixed deposit is a bank term deposit which has tenure of 5 years or more and which enjoys tax benefit under section 80 C of the IT Act. II. Post Office Time Deposits (POTDs): The Post Office Term Deposit (POTD) is similar to a bank fixed deposit, where you save money for a definite time period earning a guaranteed return through the tenure of the deposit. At the end of the deposit‘s tenure; the maturity is made up of the capital deposited and the interest it earns. POTDs have the following features:  Eligibility: Account may be opened by individual. Joint account can be opened by two adults. Account can be opened in the name of minor and a minor of 10 years and above age can open and operate the account.  Deposits: Minimum INR 200/- and in multiple thereof. No maximum limit. 7

 Interest and Tenure: Interest keeps on varying depending upon the tenure. Present interest rate for tenure of 1-5 years is between 6.9% to 7.7%, 6.9% for 2 years and 3 years deposits and 7.7% for 5 year deposits. Interest is payable annually but calculated quarterly.  Nomination facility is available at the time of opening and also after opening of account.  Company Fixed Deposits: Many investors, large and small, solicit fixed deposits from the public. Deposit(s) in Companies that earn a ―fixed rate of return‖ over a period of time are called Company Fixed Deposits. Financial Institutions and Non-Banking Finance Companies (NBFCs) accept such deposits. Acceptance of deposits by companies is governed by the applicable provisions contained in the Companies Act, 2013. These deposits are unsecured, i.e., if the company defaults, the investor cannot sell the documents to recover his capital, thus making them a risky investment option. However, these fixed deposits offer higher return than bank fixed deposits. No Income Tax is deducted at source if the interest income is up to ₹5,000 in one financial year. 1.1.4. Small Saving Schemes - National Savings Certificate (NSC), Public Provident Fund (PPF), Post Office Monthly Income Scheme (POMIS), Senior Citizens Savings Scheme (SCSS) National Savings Certificates (NSC) National Savings Certificates, popularly known as NSC, is an Indian Government Savings Bond, primarily used for small savings and income tax saving investments in India. These can be purchased from any Post Office in India. NSC VIII Issue - This scheme offers the following features:  There is no maximum limit for investment.  Certificates can be kept as collateral security to get loan from banks.  Investment up to ₹1,50,000/- per annum qualifies for IT Rebate under section 80C of Income Tax Act.  Trust and HUF cannot invest.  They are issued for 5 years maturity.  Rate of interest effective from 1st April 2019 is 8% p.a.  Maturity value of a certificate of ₹100/- purchased on or after 1.4.2014 shall be ₹148.02 after 5 years.  No tax deduction at source.  Interest earned on NSC is taxable under IT Act, 1961. Buy National Savings Certificates (NSCs) every month for Five years – Re-invest on maturity and relax - On retirement it will fetch you monthly pension as the NSC matures. 8

Public Provident Fund (PPF) Scheme The Public Provident Fund is savings-cum-tax-saving instrument in India. The scheme is fully guaranteed by the Central Government. A PPF account with any nationalized bank, selected authorized private bank or post office. One of the most attractive investment avenues available in India, the PPF Scheme has the following features:  Eligibility: Individuals who are residents of India are eligible to open their account under the Public Provident Fund. Non-resident Indians (NRIs) are not eligible to open an account under the Public Provident Fund Scheme. The account can be opened in the name of individuals including minor.  Investment and returns: A minimum yearly deposit of ₹500 is required to open and maintain a PPF account, and a maximum deposit of ₹1.5 lakhs can be made in a PPF account in any given financial year. The subscriber should not deposit more than ₹1.50 lac per annum as the excess amount will neither earn any interest nor will be eligible for rebate under Income Tax Act. The amount can be deposited in lump sum or in a maximum of 12 installments per year. The government of India decides the rate of interest for PPF account. The current interest rate effective from 1 April 2019 is 8.0% per Annum (compounded annually). Interest will be paid on 31 March every year. Interest is calculated on the lowest balance between the close of the fifth day and the last day of every month.  Tenure of the scheme: Original duration is 15 years. Thereafter, on application by the subscriber, it can be extended for 1 or more blocks of 5 years each.  Maturity: Subscriber has 3 options once the maturity period is over.[4] (i) Complete withdrawal - Subscriber can opt to withdraw the whole amount after the completion of 15 years. (ii) Extend the PPF account with no contribution – PPF account can be extended after the completion of 15 years, subscriber doesn‘t need to put any amount after the maturity. This is the default option meaning if subscriber doesn't take any action within one year of his PPF account maturity this option activates automatically. Any amount can be withdrawn from the PPF account if the option of extension with no contribution is chosen. Only restriction is only one withdrawal is permitted in a financial year. Rest of the amount keeps earning interest. (iii) Extend the PPF account with contribution - With this option subscriber can put money in his PPF account after extension. For extension, the subscriber needs to submit a request to the bank where he is having a PPF account within one year from the date of maturity (before the completion of 16 yrs in PPF). With this option subscriber can only withdraw maximum 60% of his PPF amount (amount which was there in the PPF account at the beginning of the extended period) within the entire 5 yrs block. Every year only a single withdrawal is permitted.  Loans: Loan facility available from 3rd financial year up to 5th financial year. The rate of interest charged on loan taken by the subscriber of a PPF account on or after 01.12.2011 shall be 2% more than the prevailing interest on PPF. However, the rate of 9

interest of 1% more than PPF interest p.a. shall continue to be charged on the loans already taken or taken up to 30.11.2013. Up to a maximum of 25 per cent of the balance at the end of the 2nd immediately preceding year would be allowed as loan. Such withdrawals are to be repaid within 36 months. A second loan could be availed as long as you are within the 3rd and before the 6th year, and only if the first one is fully repaid. Also note that once you become eligible for withdrawals, no loans would be permitted. Inactive accounts or discontinued accounts are not eligible for loan.  Withdrawals: There is a lock-in period of 15 years and the money can be withdrawn in whole after its maturity period. However, pre-mature withdrawals can be made from the end of the sixth financial year from when the PPF commenced. The maximum amount that can be withdrawn pre-maturely is equal to 50% of the amount that stood in the account at the end of 4th year preceding the year in which the amount is withdrawn or the end of the preceding year whichever is lower.  Tax Benefits: Annual contributions qualify for tax rebate under Section 80C of income tax up to ₹1,50,000 annually. Contributions to PPF accounts of the spouse and children are also eligible for tax deduction. The highest amount that can be deposited is 1,50,000. Tax bracket for PPF is EEE (i.e. Exempt, Exempt, Exempt). So contribution is exempted under 80C, Interest earned is tax exempted and withdrawal is also tax exempted. Interest earned is fully exempted from tax without any limits.  Defaults and Revival: If any contribution of minimum amount in any year is not invested, then the account will be deactivated. To activate the bearer needs to pay ₹50 as penalty for each inactive year. He/she also needs to deposit ₹500 each as each inactive year‘s contribution. In case death of account holder then the balance amount will be paid to his nominee or legal heir even before 15 years. Nominees or legal heirs are not eligible to continue the account of the deceased. Post Office Monthly Income Schemes (POMIS) POMIS is a popular scheme of the post office which provides regular monthly income to the depositors. Senior citizens and retirees who do not have a regular income stream should invest, given the assured returns and sovereign backing of the government. The salient features of the scheme are as follows: • Tenure: Maturity period is 5 years. • Maximum and Minimum Investment: the minimum amount of investments in ₹1500. Maximum investment limit is ₹4.5 lakhs in single account and ₹9 lakhs in joint account. • Interest Rate: The interest rate is 7.7% per annum payable monthly. 10

• Eligibility: Account may be opened by individual. Account can be opened in the name of minor and a minor of 10 years and above age can open and operate the account. Joint account can be opened by two or three adults. All joint account holders have equal share in each joint account. • Premature Withdrawals: Can be prematurely en-cashed after one year but before 3 years with 2% deduction of the deposit amount and after 3 years with 1% deduction of the deposit amount. • Taxation: There is no tax deducted at source and the interest earned as well as the bonus is added to your income and taxed. Senior Citizen Savings Scheme (SCSS) The following are the features of SCSS:  Eligibility: An individual of the Age of 60 years or more may open the account. An individual of the age of 55 years or more but less than 60 years who has retired on superannuation or under VRS can also open account subject to the condition that the account is opened within one month of receipt of retirement benefits and amount should not exceed the amount of retirement benefits. A depositor may operate more than one account in individual capacity or jointly with spouse (husband/wife).  Tenure: Maturity period is 5 years.  Minimum and Maximum Investment: There shall be only one deposit in the account in multiple of ₹1000/- maximum not exceeding ₹15 lakh. Account can be opened by cash for the amount below ₹1 lakh and for ₹1 Lakh and above by cheque only.  Interest: From 1.4.2019, interest rates are 8.7% per annum, payable from the date of deposit of 31st March/30th Sept/31st December in the first instance & thereafter, interest shall be payable on 31st March, 30th June, 30th Sept and 31st December. In case of SCSS accounts, quarterly interest shall be payable on 1st working day of April, July, October and January.  Any number of accounts can be opened in any post office subject to maximum investment limit by adding balance in all accounts. Joint account can be opened with spouse only and first depositor in Joint account is the investor.  Premature closure is allowed after one year on deduction of an amount equal to1.5% of the deposit & after 2 years 1% of the deposit. After maturity, the account can be extended for further three years within one year of the maturity by giving application in prescribed format. In such cases, account can be closed at any time after expiry of one year of extension without any deduction.  Taxation: TDS is deducted at source on interest if the interest amount is more than INR 10,000/- p.a. Investment under this scheme qualifies for the benefit of Section 80C of the Income Tax Act, 1961 from 1.4.2007. 11

1.1.5. Money Market Instruments - Treasury Bills, Commercial Paper, Certificate of Deposit, etc. Debt instruments, which have a maturity of less than one year at the time of issue, are called money market instruments. These instruments are highly liquid and have negligible risk. The money market is denominated by the government, financial institutions, banks, and corporate. Individual investors scarcely participate in the money market directly. The major money market instruments are: • Treasury bills issued for 91-day, 182-day and 364-day tenure. • Commercial paper usually issued for a 90-day tenure. • Certificates of deposits usually issued for a 90-day tenure. • Collateralised Borrowing and Lending Obligations (CBLO) with 1 to 14-day tenure. A brief description of these instruments is given below:  Treasury Bills Treasury bills are short-term instruments issued by the RBI on behalf of the government. They are currently issued for maturities of 91-days, 182-days and 364- days.The government issues T-bills for two broad purposes: • To meet short-term requirements for funds. • As part of the Market Stabilisation Scheme (MSS). T-bills are issued by the RBI every week through an auction. They are issued at a discount and redeemed at par value. The difference between the issue and redemption price, compared to the issue price and annualized, given the days to maturity of the T- bill, is the implicit yield. The yields on treasury bills are determined through the auction process. Subsequently the bills are traded in the secondary markets. The dominant buyers of T-bills are state governments and banks.  Commercial Paper Commercial Papers (CPs) are issued to meet the short term funding needs of companies, primary dealers and financial institutions. They can be issued for maturities between a minimum of 7 days and a maximum of one year from the date of issue, but the 90-day CP is most commonly issued. Issuers must obtain a credit rating for the issue of CP and the rating must not be below an ‗A3‘ rating, according to the rating symbols prescribed by SEBI for money market instruments. The yield on a CP depends on the credit rating of the paper. Higher the rating, lower the offered rate. Yields on CPs are at a spread to the T-bill rate. NBFCs are large issuers of CPs. CPs are discounted instruments which are issued at a discount and redeemed at par. They may be held in physical or dematerialized form. However, RBI regulated entities are required to compulsorily hold the instrument in dematerialised form. Stamp duties apply on issuance. 12

 Certificates of Deposits (CDs) CDs are predominantly issued by banks, to meet short-term requirements of funds. They can be issued for maturities up to 364 days. Rates on CDs are similar to bank deposit rates of the same tenure, except that they are not transactions between the bank and the depositor, but a security issued by the bank and bought by the customer. Owing to restrictions on mutual funds holdings of bank deposits, liquid funds tend to hold CDs rather than bank deposits. According to SEBI Regulations, a mutual fund‘s holding in short term deposits of banks cannot exceed 15% of its net assets. This can be raised to 20% with the approval of the trustees. The regulation also restrict the holding of the mutual fund in deposits of any one bank to 10% of its net assets and prohibits any holding in the deposits of a bank that has invested in the scheme. When liquidity is tight, banks issue CDs at higher rates to attract deposits. CD mobilization and rates tend to decline with improvement in liquidity.  Collateralised Borrowing and Lending Obligation (CBLO) Collateralised Borrowing and Lending Obligation (CBLO) is a short-term instrument used to lend or borrow for periods ranging from overnight to one year against the collateral of eligible debt securities (mostly G-Secs and T-bills). A CBLO is like a standardized repo transaction in which coupon rates depend only on the demand and supply of funds among market participants. Participants are assigned borrowing limits on the basis of securities deposited with the Clearing Corporation of India (CCIL). CCIL acts as counterparty to both sides on a CBLO deal and its system matches borrowing and lending orders. CBLOs were introduced in order to accommodate participants without access to the call money market. Mutual funds are among the biggest lenders in the CBLO segment. Overnight call markets are available only to banks and primary dealers. Mutual funds prefer CBLOs where lending is fully secured against collateral of government securities. The fund, if required, liquidates its position before maturity in the highly liquid CBLO market. Rates in CBLO markets are closely aligned to repo rates; and slightly lower than call rates. 13

1.1.6. Suitability of Regular Income Generation from Investment Portfolio Fixed-Income Instruments are income-oriented investment, provides regular income to the investor. The scope for capital appreciation is limited in fixed income instruments. A conservative investor with a short to medium term investing horizon, who is unwilling to take risks on capital and needs regular income tend to choose fixed income products. An income oriented investment provides most of its total return in the form of periodic inflows. There is limited scope for capital gains as the principal is usually returned on maturity. These investments are suitable for retired investors seeking regular income, shorter investing horizons and low-risk portfolios. They are keen to distribute their wealth and like protection of their wealth from capital erosion. Investors, who seek regular income and a lower level of risk, tend to choose debt products The issuer of debt commits to pay a pre-decided coupon rate to the investor at the time of issuance. The periodic interest payments are promised under the debt contract, and the investor has a legal right to receive them. This feature of debt makes it less risky than variable return securities (such as equity). For some categories of investors, such as retired persons, the fixed income from debt is ideal as it provides safe and certain returns on investment. Thus, regular income generating investment portfolios are suitable for:  Investors who are income seeking and are averse to risky investments.  An investor with a short to medium term investing horizon, who is unwilling to take high risks on capital and needs regular income.  Retired investors seeking regular income, shorter investing horizons and low-risk portfolios.  Investors who are seeking secondary income in additional to their primary source of income such as income from salary, rental income, etc. 14

SUMMARY  Government Securities are sovereign (credit risk-free) coupon bearing instruments which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government's market borrowing programme.  Dated Government securities are long term securities and carry a fixed or floating coupon (interest rate) which is paid on the face value, payable at fixed time periods (usually half- yearly).  Fixed Rate Bonds are bonds on which the coupon rate is fixed for the entire life of the bond. Most Government bonds are issued as fixed rate bonds.  Floating Rate Bonds are securities which do not have a fixed coupon rate. The coupon is re-set at pre-announced intervals (say, every six months or one year) by adding a spread over a base rate.  Deep discount bonds, also known as zero-coupon bonds, are bonds wherein there is no interest or coupon payment and the interest amount is factored in the maturity value.  Corporate bonds are debt instruments issued by private and public sector companies. They are issued for tenors ranging from 2 years to 15 years.  PSU bonds are medium or long term debt instruments issued by Public Sector Undertakings (PSUs).  A debenture is a debt instrument which is not backed by any specific security; instead the credit of the company issuing the same is the underlying security.  Bank fixed deposits are the simplest of investment avenues which are very safe and offer high liquidity. The interest rate on fixed deposits varies with the term of the deposit.  Deposit(s) in Companies that earn a ―fixed rate of return‖ over a period of time are called Company Fixed Deposits. Financial Institutions and Non-Banking Finance Companies (NBFCs) accept such deposits.  National Savings Certificates, popularly known as NSC, is an Indian Government Savings Bond, primarily used for small savings and income tax saving investments in India.  The Public Provident Fund is savings-cum-tax-saving instrument in India. The scheme is fully guaranteed by the Central Government.  The Post Office Term Deposit (POTD) is similar to a bank fixed deposit, where you save money for a definite time period earning a guaranteed return through the tenure of the deposit.  Treasury bills are short-term instruments issued by the RBI on behalf of the government. They are currently issued for maturities of 91-days, 182-days and 364-days.  Commercial Papers (CPs) are issued to meet the short term funding needs of companies, primary dealers and financial institutions. They can be issued for maturities between a minimum of 7 days and a maximum of one year from the date of issue, but the 90-day CP is most commonly issued. 15

 Certificates of Deposits are predominantly issued by banks, to meet short-term requirements of funds. They can be issued for maturities up to 364 days.  Collateralised Borrowing and Lending Obligation (CBLO) is a short-term instrument used to lend or borrow for periods ranging from overnight to one year against the collateral of eligible debt securities (mostly G-Secs and T-bills).  Income generating investment portfolios are suitable for Investors who are income seeking and are averse to risky investments; retired investors seeking regular income, shorter investing horizons and low-risk portfolios. Investors who are seeking secondary income in additional to their primary source of income such as income from salary, rental income, etc. also tend to invest in fixed income instruments. 16

Sub-Section 1.2 Mutual Fund Products Concept of Mutual Fund Mutual fund is a vehicle to mobilize moneys from investors, to invest in different markets and securities, in line with the investment objectives agreed upon, between the mutual fund and the investors. In other words, through investment in a mutual fund, a small investor can avail of professional fund management services offered by an asset management company. Mutual funds offer a range of products to investors. These products are designed to meet various investment objectives, which can be categorized in terms of: • Risk and return expectations • Investment horizon • Investment strategy For example, investors who are willing to take higher risks for higher level of return, tend to choose equity products. Investors who seek regular income and a lower level of risk, tend to choose debt products. Long term investors may choose equity, while investors with short to medium term horizons choose debt and debt-oriented products. Investors who anticipate an appreciation in prices of equity shares may prefer equity products over debt products. Several products may also seek to address multiple objectives. Investors with a short investing horizon, unwilling to risk their principal, and thus prefer a high quality portfolio only short term money market instruments, could find a liquid fund that meets all these objectives 1.2.1. Money Market Mutual Funds (MMMFs) and Liquid Fund Schemes Mutual funds that invest in debt securities may invest in money market securities or in longer term debt securities, or a combination of the two. The primary investment objective of liquid and debt funds is regular income generation. However, since the longer term debt markets offer the scope for capital growth, debt funds are offered along the yield curve, spanning very short term to long term products. Short Term Debt Funds Money Market or Liquid Funds are very short term maturity. They invest in debt securities with less than 91 days to maturity. However, there is no mark to market for securities less than 60 days to maturity. The primary source of return is interest income. Liquid fund is a very short-term fund and seeks to provide safety of principal and superior liquidity. It does this by keeping interest rate and credit risk low by investing in very liquid, short maturity fixed income securities of highest credit quality. Thus, these schemes are ideal for investors seeking high liquidity with safety of capital. There are ultra short-term plans which are also known as treasury management funds, or cash management funds. They invest in money market and other short term securities of maturity up to 365 days. The objective is to generate a steady return, mostly coming from accrual of interest income, with minimal NAV volatility. 17

Short Term Plan combines short term debt securities with a small allocation to longer term debt securities. Short term plans earn interest from short term securities and interest and capital gains from long term securities. The volatility in returns will depend upon the extent of long-term debt securities in the portfolio. Short term funds may provide a higher level of return than liquid funds and ultra short term funds, but will be exposed to higher mark to market risks. Consider this example. XYZ and PQR short term plans are holding 20% and 30% respectively in long term bonds. Interest rates in the market have unexpectedly fallen sharply. Which one will show a better return? The answer to this will be PQR short term plan, because it holds a higher proportion of long term securities. This is beneficial in a falling interest rate environment. 1.2.2. Debt Fund, Gilt Fund, Fixed Maturity Plan (FMP), etc. Long Term Debt Funds Long term debt funds are total return products. This means, the return is made up of both interest income and capital appreciation or depreciation, depending upon profits or losses. The value of bond held in a long term portfolio, changes with changes in interest rates. Since market interest rates and value of a bond are inversely related, any fall in the interest rates causes a mark-to-market gain in a bond portfolio and vice versa. Therefore in a falling interest rate scenario, when investors in most fixed income products face a reduced rate of interest income, long term debt funds post higher returns. This is because they have augmented their interest income with capital gains and made a higher total return. The extent of change in market prices of debt securities is linked to the average tenor of the portfolio - Higher the tenor, greater the impact of changes in interest rates. Long term debt funds choose the tenor of the instruments for the portfolio, and manage the average maturity of the portfolio, based on scheme objectives and their own interest rate views. An income fund is a debt fund which invests in both short and long term debt securities of the Government, public sector and private sector companies. An income fund may allocate a considerable portion of the portfolio to government securities given the higher liquidity in the g-sec markets. While Government securities provide safety from default and liquidity to the portfolio, corporate debt securities enable higher interest income due to the credit spread over Government securities. In the corporate bond market, an income fund tries to manage interest income from buying bonds at a spread to Government securities and manages capital gains by taking a view on the credit spread. Thus, income funds feature both interest rate risk and credit risk and their performance depends largely on movements in interest rates and credit spreads. Dynamic debt funds seek flexible and dynamic management of interest rate risk and credit risk. That is, these funds have no restrictions with respect to security types or maturity profiles that they invest in. Dynamic or flexible debt funds do not focus on long or short term segment of the yield curve, but move across the yield curve depending on where they see the opportunity for exploiting changes in yields. 18

Duration of these portfolios are not fixed, but are dynamically managed. If the manager believes that interest rates could move up, he would move the duration of the portfolio down. When the managers believe that rates are likely to go down, he would increase the duration of the portfolio. Gilt Funds invest in government securities of medium and long-term maturities. There is no risk of default and liquidity is considerably higher in case of government securities. However, Prices of government securities are very sensitive to interest rate changes. Interest rate risk is present, depending upon maturity profile. Long term gilt funds have a longer maturity and therefore, higher interest rate risk as compared to short term gilt funds. Gilt funds are popular with investors mandated to invest in G-secs. Provident Fund or PF trusts are eligible to invest in gilt funds as they have to declare annual interest income on the contributions made by investors. Fixed Maturity Plans (FMPs) are closed-end funds that invest in debt securities with maturities that match the term of the scheme. The debt securities are redeemed on maturity and paid to investors. FMPs are issued for various maturity periods ranging from 3 months to 5 years. Mutual fund companies typically keep FMPs in the pipeline, issuing one after another, particularly depending upon demand from corporate investors in the market. The return of an FMP depends on the yield it earns on the underlying securities. They typically invest only in fixed income securities like debentures of issuers with a good credit rating. The investments are spread across various issuers, but the tenor is matched with the maturity of the plan. An FMP structure eliminates the interest rate risk or price risk for investors if the fund is held passively until maturity. Therefore, even if the price of bonds held in the portfolio moves up or down, as long as the fund receives the interest payouts and the original investment on maturity, the FMP does not suffer significant risks. This makes FMPs the preferred investment in a rising interest rate environment, as investors can lock into high yields. 1.2.3. Equity Fund - Diversified Equity Schemes, Large Cap/Mid Cap/ Small Cap Funds, Sectoral Funds And Index Funds Equity funds invest in equity instruments such as shares, derivatives, and warrants. Most equity funds, are created with the objective of generating long term growth and capital appreciation. The investing horizon for equity products is also longer, given that equity as an asset class may be volatile, in the short term. Stocks are classified on the basis of market cap and industry. Classification of equity funds is based on the type of stocks they invest in. Hence, equity funds may be diversified funds, large cap funds; mid and small cap funds, sector funds, and thematic funds, depending upon the sectors and the market segment that they invest in. All equity funds are subject to market risk. Risk, is inherent, in equity markets, and therefore, an investor investing in an equity funds must be prepared for some volatility. 19

Performance of different equity funds may vary depending upon their portfolio composition. Risk inherent in equity funds can be managed through portfolio construction strategy. This may be accomplished through the extent of diversification, market segment selection, and fund management style. For example, an equity fund may be well-diversified in order to control risk. Similarly, large cap funds are considered less risky, as compared to mid-cap and small-cap funds. Mutual funds launch funds, based on market cap, such as large cap, mid cap, small cap and multi cap funds. Such funds represent a bias in terms of the stocks of companies that they invest in. Large cap funds are relatively low risk, low return investments (compared to other equity funds), as large companies tend to be well established in their businesses with stable growth and earnings. The smaller companies tend to exhibit higher growth on earnings, depending on the business opportunity and their ability to grow. However, the risk is relatively higher as smaller companies tend to also feature a higher risk of inability to withstand downturns and lower liquidity in the stock market. These funds offer a higher-risk and higher-return variation to large cap funds. Risk and return of equity funds also varies depending upon market scenario. Large cap funds out-perform mid cap funds in market fall and recovery, while mid-cap funds out- perform large cap funds in upswing, and momentum. Flexi-cap or vari-cap funds tend to exploit such opportunities. They switch between large and midcap stocks based on the fund manager‘s view of which style might outperform the benchmarks. Diversified Equity Funds invest across various sectors, sizes and industries, with the objective of beating a broad equity market index. These funds feature lower risk as the benefit of diversification kicks in and are suitable for investors with long investment horizons. Underperformance of one sector or stock may be made up for by the out-performance of any one or more of the other sectors or stocks. For example, in case of a diversified fund, if the auto sector underperforms due to rising interest rates, the same may be made up by the performance of the technology sector, or the metals sector, or the telecom sector. Thematic Equity Funds invest in multiple sectors and stocks pertaining to a specific theme. Themes are chosen by the fund managers who believe these will do well over a given period of time based on their understanding of macro trends and developments. Funds may be based on the themes of infrastructure growth, commodity cycles, public sector companies, multi-national companies, rural sector growth, businesses driven by consumption patterns and service-oriented sectors. These funds run a higher concentration risk, as compared to a diversified equity fund but are diversified within a particular theme. Such fund offer a higher return if the specific theme they focus on does better than the overall market. For example, Infrastructure funds did exceptionally well during the 2006 to 2008 market cycle, as the Indian economy grew 20

rapidly and infrastructure-related companies out-performed. They underperformed during the period 2009-2011, when the infrastructure growth slowed down in India, due to slower economic growth. Sector Funds are available for sectors such as information technology, banking, pharma and FMCG. We know that sector performances tend to be cyclical. The return from investing in a sector is never the same across time. For example, Auto sector, does well, when the economy is doing well and more cars, trucks and bikes are bought. It does not do well, when demand goes down. Banking sector does well, when interest rates are low in the market; they don‘t do well when rates are high. An investor who invested in a sector fund, such as the technology fund, would have made a high return in 2001, but made a negative return in 2002. Therefore, such funds typically feature, high risk, and are unsuitable for a longer horizon. Investments in sector funds have to be timed well. Investment in sector funds should be made when the fund manager expects the related sectors, to do well. They could out- perform the market, if the call on sector performance plays out. In case it doesn‘t, such funds could underperform the broad market. For example, an investor expecting the banking sector to out-perform as interest rates drop may incur a loss in a Banking sector fund, if the interest rates do not fall, and the banking sector continues to under-perform. An investor expecting the commodity sector to out-perform as economic growth picks up may incur a loss in a commodity-based sector fund, if the economic growth does not rise as expected. Index Funds are passively managed, where the fund manager does not take a call on stocks or the weights of the stocks in the portfolio, but simply replicates a chosen index. Replicating an index means, holding all the same stocks, in exactly the same weightage as in the index. Index funds could track the broader indices, such as Nifty and SENSEX, or could track the Index funds could track the broader indices, such as Nifty and SENSEX, or could track the sector specific Indices such as BSE IT (Technology) or Bankex (Banking). First time equity investors, who do not like to take a risk on the fund with respect to the benchmark, are typically recommended index funds. Index funds will always deliver a return equal to the return on the benchmark. A slight difference in return could be attributed to the expense ratio which is charged by the mutual fund. However, expense ratio on index funds is considerably lower that is 0.75% as maximum, as compared to, 2.50% for actively managed equity funds. Equity Linked Savings Schemes (ELSS) is a special category of diversified equity funds designated as ELSS, at the time of launch. Investment in ELSS to the extent of ₹1.5 lakh in a year enjoys a tax deduction under Section 80Cof the Income Tax Act. Investors can buy the units to claim tax deduction at any time of the financial year. An ELSS can be offered as an open-ended scheme, in which case, a fund house can have only one such scheme. Funds can also offer ELSS as a closed-end scheme. Investment in both the open and closed end ELSS is subject to a 3-year lock-in. The lock-in period will apply from the date of purchase of units. 21

During the lock-in period investors cannot sell, redeem, pledge, transfer, or in any manner alter their holding in the fund. An ELSS is required to stay invested, to the extent of at least 80% of its AUM in equity securities. In its management, an ELSS would be quite similar to a diversified equity fund. 1.2.4. Hybrid Funds / Balanced Mutual Fund Schemes and Monthly Income Plans (MIPs) Mutual fund products invest in a combination of debt and equity in varying proportions. Predominantly debt-oriented hybrids invest mostly in the debt market, but invest 5% to 35% in equity. The objective in these funds is to generate income from the debt portfolio, without taking on the risk of equity. A small allocation to equity provides a kicker to the overall return. Predominantly equity-oriented hybrid funds have up to 35% in debt for income and stability. A fund must have a minimum of 65% in equity in order to qualify for tax benefits as an equity oriented fund. Equity-oriented funds have a small allocation to debt to reduce risk from equity. There are also Dynamic asset allocation funds which have the flexibility to invest 0% to 100% in equity and debt depending upon the fund manager‘s view of the market scenario. Thus, these funds have the ability to work as a 100% debt fund or a 100% equity fund, depending upon fund manager outlook. Debt-oriented hybrids invest minimum of 70% to 95% in a debt portfolio. The debt component is conservatively managed with the focus on generating regular income, which is generally paid out in the form of periodic dividend. The credit risk and interest rate risk are taken care of by investing into liquid, high credit rated and short term debt securities. The allocation to equity is kept low and primarily in large cap stocks, to enable a small increase in return, without the high risk of fluctuation in NAV. Debt-oriented hybrids are designed to be a low risk product for an investor. These products are suitable for traditional debt investors, who are looking for an opportunity to participate in equity markets on a conservative basis with limited equity exposure. Monthly Income Plan is a debt-oriented hybrid. Though typically most debt-oriented hybrids invest maximum of 15% in equity, there are quite a few variants. Aggressive MIPs invest up to 30% in equity, while conservative MIPs invest only up to 5% equity. Predominantly equity-oriented hybrids invest in the equity market, but invest up to 35% in debt, so that some income is also generated. Balanced Funds are designed as equity-oriented funds. 22

Balanced funds are suitable to those investors who seek the growth opportunity in equity investment, but do not have a very high risk appetite. Balanced funds typically have an asset allocation of 65-80% in equity, and 20-35% in debt. The proportions in equity and debt are managed tactically by the fund managers based on their view of the markets. In an environment conducive to equity, balanced funds‘ allocation to equity may be raised to 80% in order to maximize returns. In a scenario where equity markets are incurring losses, balanced funds minimize the extent of fall in the value of the portfolio by reducing equity exposure and increasing debt exposure. Hence, it can be safely said that balanced funds work like parachutes in a falling market. 1.2.5. Exchange Traded Funds (ETFs) - Index and Sectoral Index ETFs Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or a sectoral fund but trades like a stock on an exchange. It is similar to a close- ended mutual fund listed on stock exchanges. ETF's experience price changes throughout the day as they are bought and sold. Exchange Traded Funds (ETFs) hold a portfolio of securities that replicates an index and are listed and traded on the stock exchange. The return and risk on ETF is directly related to the underlying index or asset. The expense ratio of an ETF is similar to that of an index fund. ETFs are first offered in a New Fund Offer (NFO) like all mutual funds. Units are credited to demat account of investors and ETF is listed on the stock exchange. On-going purchase and sale is done on the stock exchange through trading portals or stock brokers. Settlement is like a stock trade, and debit or credit is done to the demat account. ETF prices are real-time and known at the time of the transaction, unlike NAV which is computed end of a business day. Their value changes on a real-time basis along with changes in the underlying index. First time equity Investors who do not wish to seek benefits of active portfolio management strategy, and are satisfied with the returns linked to an index, are likely to find ETFs suitable. Gold ETFs are most popular form of ETFs in India. In India we have three broad categories of ETFs that have been listed: 1. Index ETF 2. Commodity ETF 3. Liquid ETF An Index ETF is based on an index published by the exchange, for example the Nifty or the Junior Nifty indices. These ETFs allow investors to invest their money in a basket of stocks in an index at a very small amount, usually one tenth (1/10th) of the index value. Nifty ETF – approx. ₹800 per ETF unit. A Commodity ETF like Gold ETF allows the investors to invest in the commodity directly from the stock market without the need to open a commodities trading account. Also it 23

allows investment at a smaller ticket size as compared to the typical commodity market ticket size. The Liquid ETF offers an easy route for parking idle funds. Using the Liquid ETF the investors can ensure that their money earns interest even for the idle time when it is not invested in other assets. 1.2.6. Gold ETFs and Other Commodity ETFs Commodity ETF invests in commodities such as precious metals and futures. In India, we only have Gold ETF. However, other Commodity ETFs such as silver ETF, Oil ETF, Precious metals ETF, etc. are traded in other countries Gold ETF is a passively managed open-ended ETF, which invests in gold bullion and instruments with gold as underlying, so as to provide investment returns that, closely track the performance of domestic prices of Gold in the bullion market. Thus, rising gold prices would be beneficial for the investor. Of course, the actual returns may be just a tad lower due to the effect of expense ratio on fund management. When an investor invests in Gold ETF, the mutual fund buys physical gold of 99.5% purity which is preserved safely by the custodian. Hence, impurity risk in gold ETF is absent. Gold ETF allows investors to buy gold in quantities as low as 1gm. This is done in the form of demat units where each unit approximately represents the value of 1 gm of Gold. Hence, investors can even use small amounts to invest in gold. 1.2.7. Funds Investing in Overseas Securities and Arbitrage Funds Funds Investing in Overseas Securities International funds invest in markets outside India, by holding certain foreign securities in their portfolio. The allowable securities in Indian international funds include Equity of companies listed abroad, ADRs and GDRs of Indian companies, Debt of companies listed abroad, ETFs of other countries, Units of index funds in other countries, Units of actively managed mutual funds in other countries. International equity funds may also hold some of their portfolios in Indian equity or debt. They can also hold some portion of the portfolio in money market instruments to manage liquidity. The overseas investment limit for resident individuals has gone up from US$ 25,000 to US$ 2,00,000 per year. The definition of equity-oriented funds in the Income Tax Act refers only to investment in equity shares of domestic companies. If an international fund invests at least 65% of net assets in domestic equity, and the rest abroad, only then it will be treated as an equity- oriented fund. Therefore, international funds that invest in equity shares overseas, will not be classified as equity-oriented funds for purposes of taxation 24

Rewards Risks Portfolio diversification from exposure Political events and macro economic to global markets. factors cause investments to decline in value. Benefits from investing in asset classes not available domestically. Investment's value will be impacted by changes in exchange rates. Opportunity to improve long-term portfolio performance from picking Countries may change their investment global leaders. policy towards global investors. Arbitrage Funds Arbitrage Funds aim at taking advantage of the price differential between the cash and the derivatives markets. Arbitrage is defined as simultaneous purchase and sale of an asset to take advantage of difference in prices in different markets. The difference between the future and the spot price of the same underlying is an interest element, representing the interest on the amount invested in spot, which can be realized on a future date, when the future is sold. Funds buy in the spot market and sell in the derivatives market, to earn the interest rate differential. For example, funds may buy equity shares in the cash market at Rupees 80 and simultaneously sell in the futures market at ₹100, to make a gain of Rupees 20. If the interest rate differential is higher than the cost of borrowing there is a profit to be made. The price differential between spot and futures is locked in if positions are held until expiry of the derivative cycle. On settlement date both positions are closed at the same price, to realize the difference. A completely hedged position makes these funds a low-risk investment proposition. They feature lower volatility in NAV, similar to that of a liquid fund. 1.2.8. Distribution and Sales Practices of Mutual Fund Schemes Institutional Channels Historically, individual agents would distribute units of Unit Trust of India and insurance policies of Life Insurance Corporation. They would also facilitate investments in Government‘s Small Savings Schemes. Further, they would sell Fixed Deposits and Public Issues of shares of companies, either directly, or as a sub-broker of some large broker. The changing competitive context led to the emergence of institutional channels of distribution for a wide spectrum of financial products. This comprised:  Brokerage firms and other securities distribution companies, who widened their offering beyond company Fixed Deposits and public issue of shares.  Banks, who started viewing distribution of financial products as a key avenue to earn fee based income, while addressing the investment needs of their customers. Some operated within states; many went national. A chain of offices manned by professional employees or affiliated sub-brokers became the face of mutual fund 25

distribution. Brand building, standardized processes and technology sharing became drivers of business for these institutions – unlike the personal network, which generated volumes for the individual agents. The institutional channels started attracting agents as sub-brokers. Many individual agents opted to associate with the institutional channels, so that they could give their customers the benefit of newer technologies and services (which the agents found too costly to offer on their own). Thus, the distribution setup has got re-aligned towards a mix of:  Independent Financial Advisors (IFAs), who are individuals. The bigger IFAs operate with support staff who handles back-office work, while they themselves focus on sales and client relationships.  Non-bank distributors, such as brokerages, securities distribution companies and nonbanking finance companies.  Bank distributors Ownership of all-India or regional network of locations meant that the institutional channels could deal with product manufacturers as equals, and negotiate better terms than what the agents could manage. Down the line, the AMCs also started exploring other channels of distribution. Post offices and self-help groups are examples of such alternate channels. Newer Distribution Channels Internet The internet gave an opportunity to mutual funds to establish direct contact with investors. Direct transactions afforded scope to optimize on the commission costs involved in distribution. Investors, on their part, have found a lot of convenience in doing transactions instantaneously through the internet, rather than get bogged down with paper work and having to depend on a distributor to do transactions. This has put a question mark on the existence of intermediaries who focus on pushing paper, but add no other value to investors. A few professional distributors have rightly taken the path of value added advice and excellent service level to hold on to their customers and develop new customer relationships. Many of them offer transaction support through their own websites. A large mass of investors in the market need advice. The future of intermediaries lies in catering to their needs, personally and / or through a team and / or with support of technology. Stock Exchanges SEBI has also facilitated buying and selling of mutual fund units through the stock exchanges. Both NSE and BSE have developed mutual fund transaction engines for the purpose. The underlying premise is that the low cost and deeper reach of the stock exchange network can increase the role of retail investors in mutual funds, and take the mutual fund 26

industry into its next wave of growth. While the transaction engines are a new phenomenon, stock exchanges always had a role in the following aspects of mutual funds.  Close-ended schemes are required to be listed in a stock exchange  ETFs are bought and sold in the stock exchange. New Cadre of Distributors SEBI, in September 2012, provided for a new cadre of distributors, such as postal agents, retired government and semi-government officials (class III and above or equivalent), retired teachers and retired bank officers with a service of at least 10 years, and other similar persons (such as Bank correspondents) as may be notified by AMFI/ AMC from time to time. These new distributors are allowed to sell units of simple and performing mutual fund schemes. Simple and performing mutual fund schemes comprise of diversified equity schemes, fixed maturity plans (FMPs) and index schemes that have returns equal to or better than their scheme benchmark returns during each of the last three years. These new cadre of distributors require a simplified form of NISM certification and AMFI Registration. Channel Management Practices Commission Structures There are no SEBI regulations regarding the minimum or maximum commission that distributors can earn. However, SEBI has laid down limits on what the total expense (including commission) in a scheme can be. This is discussed in Chapter 6. Any excess will need to be borne by the AMC i.e. it cannot be charged to the scheme. The commission structures vary between AMCs. Even for the same AMC, different commissions are applicable for different kinds of schemes. Two kinds of commission are earned by distributors on their mobilization: Initial or Upfront Commission, on the amount mobilized by the distributor. The scheme application forms carry a suitable disclosure to the effect that the upfront commission to distributors will be paid by the investor directly to the distributor, based on his assessment of various factors including the service rendered by the distributor. Some distributors have worked out standardized contracts with their clients, where either a fixed amount per period or a percentage of the transaction value is recovered as fees. As part of the contract, some banks debit the commission to the investor‘s savings bank account held with the bank. Investors should make sure that the commission costs they incur are in line with the value they get. Trail commission, calculated as a percentage of the net assets attributable to the Units sold by the distributor. The trail commission is normally paid by the AMC on a quarterly basis. Since it is calculated on net assets, distributors benefit from increase in net assets arising out of valuation gains in the market. 27

For example, suppose an investor has bought 1000 units at ₹10 each. The distributor who procured the investment may have been paid an initial commission calculated as a percentage on 1000 units X ₹10 i.e. ₹10,000. Later, suppose the NAV of the scheme goes up to ₹15. Trail commission is payable on 1000 units X ₹15 i.e. ₹15,000 – not the ₹10,000 mobilised. Further, unlike products like insurance, where agent commission is paid for a limited number of years, a mutual fund distributor is paid a commission for as long as the investor‘s money is held in the fund. Such indexing of agent commissions to the share market, and the absence of a time limitation to earning it, are unique benefits that make it attractive for distributors to sell mutual funds. Smart distributors have accumulated a portfolio of loyal investors to whom they offer superior service. The trail commission on these investments ensures a steadily rising income for the distributor. Additional investments from the same investors, and other investors referred by the current investors, help them grow the portfolio. A point to note is that the commission is payable to the distributors to mobilise money from their clients. Hence, no commission – neither upfront or trail – is payable to the distributor for their own investments (self business). SEBI Regulations Related to Sales Practices Distributors can claim commission on investments made through them by their clients. However, no commission is payable on their own investments. The distributors have to disclose all the commissions (in the form of trail commission or any other mode) payable to them for the different competing schemes of various mutual funds from amongst which the scheme is being recommended to the investor. The practice of rebating i.e., sharing part of the commission earned with the investors is banned. 28

SUMMARY  Mutual fund is a vehicle to mobilize moneys from investors, to invest in different markets and securities, in line with the investment objectives agreed upon, between the mutual fund and the investors.  Money Market or Liquid Funds are very short term maturity. They invest in debt securities with less than 91 days to maturity. However, there is no mark to market for securities less than 60 days to maturity.  Short Term Plan combines short term debt securities with a small allocation to longer term debt securities.  Long term debt funds are total return products. This means, the return is made up of both interest income and capital appreciation or depreciation, depending upon profits or losses.  An income fund is a debt fund which invests in both short and long term debt securities of the Government, public sector and private sector companies. An income fund may allocate a considerable portion of the portfolio to government securities given the higher liquidity in the g-sec markets.  Gilt Funds invest in government securities of medium and long-term maturities. There is no risk of default and liquidity is considerably higher in case of government securities  Fixed Maturity Plans (FMPs) are closed-end funds that invest in debt securities with maturities that match the term of the scheme. The debt securities are redeemed on maturity and paid to investors. FMPs are issued for various maturity periods ranging from 3 months to 5 years.  Diversified Equity Funds invest across various sectors, sizes and industries, with the objective of beating a broad equity market index. These funds feature lower risk as the benefit of diversification kicks in and are suitable for investors with long investment horizons.  Thematic Equity Funds invest in multiple sectors and stocks pertaining to a specific theme. Themes are chosen by the fund managers who believe these will do well over a given period of time based on their understanding of macro trends and developments.  Sector Funds are available for sectors such as information technology, banking, pharma and FMCG. We know that sector performances tend to be cyclical. The return from investing in a sector is never the same across time.  Index Funds are passively managed, where the fund manager does not take a call on stocks or the weights of the stocks in the portfolio, but simply replicates a chosen index. Replicating an index means, holding all the same stocks, in exactly the same weightage as in the index.  Equity Linked Savings Schemes (ELSS) is a special category of diversified equity funds designated as ELSS, at the time of launch. Investment in ELSS to the extent of ₹1.5 lakh in a year enjoys a tax deduction under Section 80Cof the Income Tax Act. Investors can buy the units to claim tax deduction at any time of the financial year.  Monthly Income Plan is a debt-oriented hybrid. Though typically most debt-oriented hybrids invest maximum of 15% in equity, there are quite a few variants. Aggressive MIPs invest up to 30% in equity, while conservative MIPs invest only up to 5% equity. 29

 Exchange Traded Fund is a security that tracks an index, a commodity or a sector like an index fund or a sectoral fund but trades like a stock on an exchange. It is similar to a close- ended mutual fund listed on stock exchanges. ETF's experience price changes throughout the day as they are bought and sold.  Gold ETF is a passively managed open-ended ETF, which invests in gold bullion and instruments with gold as underlying, so as to provide investment returns that, closely track the performance of domestic prices of Gold in the bullion market.  International funds invest in markets outside India, by holding certain foreign securities in their portfolio. The allowable securities in Indian international funds include Equity of companies listed abroad, ADRs and GDRs of Indian companies, Debt of companies listed abroad, ETFs of other countries, Units of index funds in other countries, Units of actively managed mutual funds in other countries.  Arbitrage Funds aim at taking advantage of the price differential between the cash and the derivatives markets 30

Sub-Section 1.3 Equity Market 1.3.1. Major Stock Exchange Indices - SENSEX and Nifty, their basis and composition The most widely tracked indices in India are the S&P BSE Sensitive Index (SENSEX) and the CNX Nifty (Nifty). S&P BSE SENSEX The S&P BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply the SENSEX, is a free-float market-weighted stock market index of 30 well- established and financially sound companies listed on Bombay Stock Exchange. The 30 component companies which are some of the largest and most actively traded stocks, are representative of various industrial sectors of the Indian economy. S&P BSE SENSEX today is widely reported in both domestic and international markets through print as well as electronic media. It is scientifically designed and is based on globally accepted construction and review methodology. The SENSEX has been computed since April 1, 1979 and is India‘s oldest and most tracked stock index. The base value of the SENSEX is taken as 100 on April 1, 1979. The composition of stocks in the SENSEX is reviewed and modified by the BSE index committee according to strict guidelines in order to ensure that it remains representative of stock market conditions. The criteria for selection of a stock in the SENSEX include factors such as listing history, trading frequency, market capitalization, industry importance and overall track record. The BSE has some reviews and modifies its composition to be sure it reflects current market conditions. The index is calculated based on a free float capitalisation method, a variation of the market capitalisation method. Instead of using a company's outstanding shares it uses its float, or shares that are readily available for trading. As per free float capitalisation 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 capitalisation of a company is determined by multiplying the price of its stock by the number of shares issued by of corporate actions, replacement of scrips. The index has increased by over twenty five times from June 1990 to the present. Using information from April 1979 onwards, the long-run rate of return on the S&P BSE SENSEX works out to be 18.6% per annum. NIFTY The CNX Nifty is a well diversified 50 stock index accounting for 23 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds. CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL). IISL is India's first specialised company focused upon the index as a core product. 31

 The CNX Nifty Index represents about 66.8% of the free float market capitalization of the stocks listed on NSE as on March 29, 2019.  The total traded value for the last six months ending March 2019 of all index constituents is approximately 53.4% of of the traded value of all stocks on the NSE.  Impact cost of the CNX Nifty for a portfolio size of ₹50 lakhs is 0.02% for the month March 2019.  CNX Nifty is professionally maintained and is ideal for derivatives trading. Method of Computation CNX Nifty is computed using free float market capitalization weighted method, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value. Base Date and Value The base period selected for CNX Nifty index is the close of prices on November 3, 1995, which marks the completion of one year of operations of NSE's Capital Market Segment. The base value of the index has been set at 1000 and a base capital of ₹2.06 trillion. The selection of shares that constitute the index is based on factors such as liquidity, availability of floating stock and size of market capitalization. The index is reviewed every six months and appropriate notice is given before stocks that make up the index are replaced. 1.3.2. Concept of Investing in Equity Shares - Shareholder Rights Investing in equity shares of a company means investing in the future earning capability of the company. The return to an investor in equity is in two forms – dividend that may be periodically paid out and changes in the value of the investment in the secondary market over the period of time. The return to the equity investor depends on the future residual cash flows of the company or the profits remaining after every other claim has been paid. A company may use such surplus to pay dividends or may deploy them in the growth of the business by acquiring more assets and expanding its scale. An investor therefore buys equity shares with an eye on the future benefits in terms of dividends and appreciation in value. The return to an investor depends on the price he pays to participate in these benefits and the future benefits accruing as expected. The risk to an equity investor is that the future benefits are not assured or guaranteed, but have to be estimated and revised based on dynamic changes to the business environment and profitability of the business. Equity share capital has distinct features which define its risk and return. These features determine the suitability of raising equity capital for the company over other sources of financing such as debt. For the investors, the risk and return in the equity investment determine whether such investment is appropriate for their needs. 32

Ownership Rights Shareholders are the owners of the company and have the right to participate in its profits and growth. Since equity shares are issued for perpetuity, the ownership claims are valid as long as the issuing company exists. Shareholders exercise their ownership rights by voting on all major resolutions of the company. The voting rights are in proportion to the number of shares held by the shareholders and allow them to express their views by voting for or against a proposal. In theory, shareholders can get rid of poorly performing management by voting in a new board of directors which in turn can appoint a competent management team. In practice however, public shareholders are too small or widely scattered and only institutional shareholders have some influence on corporate governance. Residual Claim Shareholders hold two positions within a company. As investors, they are entitled to a return on their investment. But as owners of the company they are obliged to pay off all the money owed to external (non-owner) creditors first, before taking their return. This problem is resolved by paying shareholders only after all operating expenses, depreciation charges, interest costs and taxes are paid from the company‘s revenues. Thus the payment made to shareholders is a share of profit after tax (PAT) in the form of dividends. Shareholders are ranked last both for profit sharing as well claiming a share of the company‘s assets. If a company goes bankrupt and has to be liquidated, the money generated from converting assets into cash cannot be claimed by equity shareholders until creditors and preference shareholders have been paid. Reserves and Net Worth Companies are not obliged to payout dividends every year, nor are dividend rates fixed or pre-determined. If companies are growing rapidly and have large investment needs, they may choose to forego dividend and instead retain their profits within the company. The share of profits that is not distributed to shareholders is known as retained profits. Retained profits become part of the company‘s reserve funds. Reserves also belong to the shareholders, though it remains with the company until it is used in operations or distributed as dividend. Reserves represent retained profits that have not been distributed to the rightful owners of the same, namely the equity investors. They enhance the net worth of a company and the book value of the equity shares. If the company is making losses and cannot pay interest (even from its reserve funds) then it is not permitted to declare any dividend for its shareholders. As soon as it returns to profits, it must first clear its interest dues before paying out dividend. Limited Liability Equity shareholders are owners of the company, but their obligation to the company is limited to the amount they agree to contribute as capital. If a company falls into bad times and goes bankrupt, and does not have adequate assets to cover its dues, equity shareholders cannot be called upon to make good the shortfall. Their liability is limited to the amount 33

they have agreed to pay, to buy the equity shares of the company, when such shares were issued to them. Returns are not Fixed Investment in equity shares does not come with a guarantee of income or security for the investor. The income to the investor from equity is in the form of dividends and capital appreciation that can be gained if the equity shares quote at prices that are higher than the purchase price, in the equity market. Neither of these is guaranteed by the company or any other entity. At the time of the issue of shares the company does not commit to pay a periodic dividend to the investor or a pre-fixed date for payment of dividend, if any. The investor cannot take any action against the company if dividends are not declared or if the share value depreciates. When a company has grown in operations and needs additional capital it typically approaches public investors from whom it seeks equity capital. Such issue of capital to other investors happens in the primary markets. 1.3.3. Equity Shares - Blue-chip, Growth and High Dividend Yield Shares Common stocks appeal to investors because they offer the potential for everything from current income and stability of capital to attractive capital gains. The market contains a wide range of stocks, from the most conservative to the highly speculative. Generally the kind of stocks that investors seek will depend on their investment objectives and risk appetite. We will examine several of the most popular types of common stocks here, as well as the various ways such securities can be used in different types of financial goals. A stock‘s general classification reflects not only its fundamental source of return but also the quality of the company‘s earnings, the issue‘s susceptibility to market risks, the nature and stability of its earnings and dividends, and even its susceptibility to adverse economic conditions. Such insight is useful in selecting stocks that will best fit the client‘s overall investment portfolio. Among the many different types of stocks, the following are the most common: Blue-Chip stocks, Growth stocks, High-Dividend Yield stocks, Mid-Cap stocks and Small-Cap stocks. Blue-Chip Stocks Blue chips are the cream of the common stock crop. They are stocks that are unsurpassed in quality and have a long and stable record of earnings and dividends. Blue-chip stocks are issued by large, well established firms that have impeccable financial credentials. These companies hold important, often leading positions in their industries and frequently set the standards by which other firms are measured. Not all blue chips are alike, however, some provide consistently high dividend yield; others are more growth oriented. While blue-chip stocks are not immune from bear markets, they do nonetheless provide the potential for relatively attractive long-term returns. They tend to appeal to investors who are looking for quality investment outlets that offer decent dividend yields and respectable growth potential. They are often used for long-term investment purposes and, because of their relatively low risk, as a way of obtaining modest but dependable rates of return. 34

Growth Stocks Shares that have experienced, and are expected to continue experiencing, consistently high rates of growth in operations and earnings are known as growth stocks. A good growth stock might exhibit a sustained rate of growth in earnings of 15% to 18% per year over a period when common stocks, on average, are experiencing growth rates of only 6% to 8%. Generally speaking, established growth companies combine steady earnings growth with high quality on equity. They also have high operating margins and plenty of cash flow to service their debt. Some growth stocks also rate as blue chips and provide quality growth, whereas others represent higher levels of speculation. Growth stocks normally pay little or nothing in the way of dividends. Their payout ratios seldom exceed 10% to 15% of earnings. Instead, all or most of the profits are reinvested in the company and used to help finance rapid growth. Thus, the major source of return to investors is price appreciation – and that can have both a good side and a bad side. That is, with growth stocks, when the markets are good, these stocks are hot. When the markets turn down, so do these stocks, often in a big way, Growth shares generally appeal to investors who are looking for attractive capital gains rather than dividends and who are willing to assume a higher element of risk. High-Dividend Yield Stocks Some stocks are appealing simple because of the dividends they pay. This is the case with high-dividend yield stocks or income stocks. These issues have a long and sustained record of regularly paying higher-than-average dividends. High-Dividend stocks are ideal for those who seek a relatively safe and high level of current income from their investment capital. Holders of high-dividend stocks (unlike bonds and preferred stocks) can expect their dividends they receive to increase regularly over time. The major disadvanatge of high-dividend stocks is that some of them may be paying high dividends because of limited growth potential. Indeed, it‘s not unusual for income securities to exhibit only low or modest rates of growth in earnings, This does not mean that such firms are unprofitable or lack future prospects. Quite the contrary, most firms whse shares qulaify as high dividend stocks are higlky profitable orgnaistons with excellent future prospects. By their very nature, high-dividend stocks are not exposed to a great deal of business and market risks. They are, however, subject to a fair amount of interest rate risk. Mid-Cap Stocks A stock‘s size is based on its market value – or more commonly, its market capitalization. This value is calculated as the market price of the stock times the number of shares outstanding. The large cap stocks are the real biggies - Infosys, TCS, and Wipro are classified as large cap stocks. These companies have been around in the industry long enough and have firmly established themselves as leading players. Their stocks are publicly traded and have large market capitalisations. But as the saying goes-bigger isn‘t necessary better. Nowhere is that statement more accurate than in the stock market. Indeed, both the small-cap and mid-cap segments of the market tend to hold their own, or even outperform large stocks over time. 35

Mid-Cap stocks offer investors some attractive return opportunities. They provide much of the sizzle of small-stock returns, without as much price volatility. At the same time, because mid-caps are fairly good sized companies and many of them have been around for a long time, they offer some of the safety of the big, established stocks. Although these securities offer a nice alternative to large stocks without the uncertainties of small caps, they probably are most appropriate for investors who are willing to tolerate a bit more risk and price volatility than large caps have. Small-Cap Stocks Lying at the lowest end of market capitalisation, Small cap stocks are generally viewed under the misconception of being hazardous or 'quick rich' stocks. However, both these labels are untrue. Small cap companies have smaller revenue and client bases, and usually include the start- ups or companies in the early stage of development. Small cap stocks are potentially big gainers as they are yet to be discovered within the sector and can show growth potential in large numbers once unfurled in the market. However, as these enterprises are small ventures, these should be researched properly. This is considering that a lot of small companies do not have the financial strength to survive bad times and some of them might be mismanaged businesses run by greedy promoters. Hence it is essential, especially in the case of small caps investments that one does a thorough research regarding the promoters' credentials, management strength and track record, and long and short term growth plans of the company before investing. Small caps are often stated to be a platform to make big returns in a short span of time. However, we would state that small caps can prove to be a very wise 'long term' investments especially if the chosen companies are good businesses and are well-managed. Although some of these stocks may hold the potential for high returns, investors should also be aware of the very high risk exposure that comes with many of them. 1.3.4. Stock Trading To trade means to buy and sell in the jargon of the financial markets. Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price. Some exchanges are physical locations where transactions are carried out on a trading floor. You've probably seen pictures of a trading floor, in which traders are wildly throwing their arms up, waving, yelling, and signaling to each other. The other type of exchange is virtual, composed of a network of computers where trades are made electronically. The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, reducing the risks of investing. Just imagine how difficult it would be to sell shares if you had to call around the neighborhood trying to find a buyer. Really, a stock market is nothing more than a super-sophisticated farmers' market linking buyers and sellers. Most of the trading in the Indian stock market takes place on its two stock exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Both exchanges follow the same trading mechanism, trading hours, settlement process, etc. Almost all the 36

significant firms of India are listed on both the exchanges. Both exchanges compete for the order flow that leads to reduced costs, market efficiency and innovation. Trading Mechanism Trading at both the exchanges takes place through an open electronic limit order book, in which order matching is done by the trading computer. There are no market makers or specialists and the entire process is order-driven, which means that market orders placed by investors are automatically matched with the best limit orders. As a result, buyers and sellers remain anonymous. The advantage of an order driven market is that it brings more transparency, by displaying all buy and sell orders in the trading system. However, in the absence of market makers, there is no guarantee that orders will be executed. All orders in the trading system need to be placed through brokers, many of which provide online trading facility to retail customers. Institutional investors can also take advantage of the direct market access (DMA) option, in which they use trading terminals provided by brokers for placing orders directly into the stock market trading system. Settlement Cycle and Trading Hours Equity spot markets follow a T+2 rolling settlement. This means that any trade taking place on Monday, gets settled by Wednesday. All trading on stock exchanges takes place between 9:15 am and 3:30 pm, Monday through Friday. Delivery of shares must be made in dematerialized form, and each exchange has its own clearing house, which assumes all settlement risk, by serving as a central counterparty. Market Indexes The two prominent Indian market indexes are Sensex and Nifty. Sensex is the oldest market index for equities; it includes shares of 30 firms listed on the BSE. Another index is the S&P CNX Nifty; it includes 50 shares listed on the NSE Market Regulation The overall responsibility of development, regulation and supervision of the stock market rests with the Securities & Exchange Board of India (SEBI), which was formed in 1992 as an independent authority. Since then, SEBI has consistently tried to lay down market rules in line with the best market practices. It enjoys vast powers of imposing penalties on market participants, in case of a breach. Who Can Invest In India? India started permitting outside investments only in the 1990s. Foreign investments are classified into two categories: foreign direct investment (FDI) and foreign portfolio investment (FPI). All investments in which an investor takes part in the day-to-day management and operations of the company, are treated as FDI, whereas investments in shares without any control over management and operations, are treated as FPI. For making portfolio investment in India, one should be registered either as a foreign institutional investor (FII) or as one of the sub-accounts of one of the registered FIIs. Both registrations are granted by the market regulator, SEBI. 37

For making portfolio investment in India, one should be registered either as a foreign institutional investor (FII) or as one of the sub-accounts of one of the registered FIIs. Both registrations are granted by the market regulator, SEBI. By default, the maximum limit for portfolio investment in a particular listed firm, is decided by the FDI limit prescribed for the sector to which the firm belongs. However, there are two additional restrictions on portfolio investment. First, the aggregate limit of investment by all FIIs, inclusive of their sub-accounts in any particular firm, has been fixed at 24% of the paid- up capital. However, the same can be raised up to the sector cap, with the approval of the company's boards and shareholders. 1.3.5. Market Performance Analysis and Technical Analysis of Indices Market Performance Analysis Stock Market Analysis deals with the performance of a particular stock market. The performance of a stock market depends upon the performance of the total number of stocks that are traded in that market. When the market closes with the prices of most of its stock on the higher side, then it can be said to have performed well. The efficient-market hypothesis suggests that stock price movements are governed by the random walk hypothesis and thus are inherently unpredictable. Others disagree and those with this viewpoint possess myriad methods and technologies which purportedly allow them to gain future price information. The Random Walk Hypothesis When applied to a particular financial instrument, the random walk hypothesis states that the price of this instrument is governed by a random walk and hence is unpredictable. If the random walk hypothesis is false then there will exist some (potentially non-linear) correlation between the instrument price and some other indicator(s) such as trading volume or the previous day's instrument closing price. If this correlation can be determined then a potential profit can be made. Prediction methodologies fall into three broad categories which can (and often do) overlap. They are fundamental analysis, technical analysis (charting) and technological methods. Fundamental Analysis Fundamental Analysts are concerned with the company that underlies the stock itself. They evaluate a company's past performance as well as the credibility of its accounts. Many performance ratios are created that aid the fundamental analyst with assessing the validity of a stock, such as the P/E ratio. Warren Buffett is perhaps the most famous of all Fundamental Analysts. Fundamental analysis is built on the belief that human society needs capital to make progress and if a company operates well, it should be rewarded with additional capital and result in a surge in stock price. Fundamental analysis is widely used by fund managers as it is the most reasonable, objective and made from publicly available information like financial statement analysis. 38

Another meaning of fundamental analysis is beyond bottom-up company analysis, it refers to top-down analysis from first analyzing the global economy, followed by country analysis and then sector analysis, and finally the company level analysis. Technical Analysis Technical analysts or chartists are not concerned with any of the company's fundamentals. They seek to determine the future price of a stock based solely on the (potential) trends of the past price (a form of time series analysis). Numerous patterns are employed such as the head and shoulders or cup and saucer. Alongside the patterns, statistical techniques are used such as the exponential moving average (EMA). Candle stick patterns are believed to be first developed by Japanese rice merchants, and nowadays widely used by technical analysts. Technical Analysis of Indices Technical analysis is a method of evaluating securities by analyzing the statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Technical analysis involves studying the price and volume patterns to understand how buyers and sellers are valuing a stock and acting on such valuation. There are three essential elements in understanding price behavior: a) The history of past prices provides indications of the underlying trend and its direction. b) The volume of trading that accompanies price movements provides important inputs on the underlying strength of the trend. c) The time span over which price and volume are observed factors in the impact of long term factors that influence prices over a period of time. Technical analysis integrates these three elements into price charts, points of support and resistance in charts and price trends. By observing price and volume patterns, technical analysts try to understand if there is adequate buying interest that may take prices up, or vice versa. Technical analysts have also created a number of technical indicators which help them judge the relative strength of buying and selling interest in the markets. Technical Analysis: The Use of Trend One of the most important concepts in technical analysis is that of trend. The meaning in finance isn't all that different from the general definition of the term - a trend is really nothing more than the general direction in which a security or market is headed. Take a look at the chart below: In any given chart, you will probably notice that prices do not tend to move in a straight line in any direction, but rather in a series of highs and lows. In technical analysis, it is the movement of the highs and lows that constitutes a trend. For example, an uptrend is 39

classified as a series of higher highs and higher lows, while a downtrend is one of lower lows and lower highs. Figure 2 Figure 2 is an example of an uptrend. Point 2 in the chart is the first high, which is determined after the price falls from this point. Point 3 is the low that is established as the price falls from the high. For this to remain an uptrend, each successive low must not fall below the previous lowest point or the trend is deemed a reversal. There are three types of trend:  Uptrends  Downtrends  Sideways/Horizontal Trends As the names imply, when each successive peak and trough is higher, it's referred to as an upward trend. If the peaks and troughs are getting lower, it's a downtrend. When there is little movement up or down in the peaks and troughs, it's a sideways or horizontal trend. 40