J B GUPTA CLASSES

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Chapter 5
MUTUAL FUNDS
Chapter Index
NAV Returns Extra Practice (Must Do) Extra Practice (Optional) Theoretical Aspects (a) Mutual Funds Different Types of Schemes (b) Regulation of Mutual Funds (c) Establishment o Mutual Funds (d) Role of Mutual Funds in the Financial Markets (e) Right and Obligations of the Investors (f) Advantages of the Investing in the Mutual Funds (g) Disadvantages of the Investing in the Mutual Funds (h) Fund of Funds

A MUTUAL fund is an organization (in India this organization must be in the form of a trust) that pools the savings of a number of investors called as unit holders who share a common goal. The money thus collected is invested by the professional fund managers in different types of securities depending upon the objectives of the scheme. The return/ loss on investment is shared by the unit holders in proportion to the number of units owned by them. NAV: The net assets value of any MF scheme is the current value of its all assets net of its liabilities. Division of this amount by number of outstanding units of the scheme, we get NAV per unit. NAV per unit represents the amount which the holder of one unit will get if the scheme is dissolved or liquidated (for this calculation, forced or distress sale is not assumed, moreover the liquidation or dissolution costs are not considered). NAV per unit is generally called as NAV (ignoring the phrase per unit ).

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NAV of a fund scheme is equal to: (1) Market value of traded listed securities + (2) Estimated value of (i) Non-traded listed securities (ii) Unlisted securities + (3) Liquid assets/ cash + (4) Accrued dividend/interest - (5) Accrued expenses - (6) Other liabilities The most important part of calculation of NAV is valuation of non-traded listed securities and unlisted securities. (Non-traded listed security is a security, which though listed, has not been traded in any stock exchange for a period of 60 days prior to the valuation date.) Non-traded listed securities and unlisted securities should be valued by Asset Management Company in good faith on the basis of appropriate methods. The auditors are supposed to give their opinion on such valuations, for valuation of such securities, following principles should be followed: (i) Equity shares should be valued either on the basis of Earning Price (EP) ratio or in combination with net assets value. The basis of EP ratio method is EP ratio of comparable traded security. For example, equity shares of X Ltd. are non-traded security. Its EPS is Rs.20. EP ratio of Y Ltds equity shares (which is a comparable traded security) is 10%. For the purpose of valuation of equity shares, EP ratio should be taken as more than 10% (because of lower liquidity of equity shares of X Ltd.), say 12.50%. The value of equity shares of X Ltd. may be taken as 20/0.125 i.e. Rs.160. (ii) Debt instruments should be valued on the basis of Yield to maturity of the asset to be valued and adjusted YTM of the comparable traded security. Suppose face value of a debenture of X Ltd. is Rs.100. Its yield to maturity is 8%. YTM of a comparable traded security is 10% i.e. normal rate of a comparable security is 10%. Normal rate of debentures of X Ltd. may be taken slightly on higher side, say 10.50%, as Debentures of X ltd. are unlisted (lower liquidity). In this case, the value of debenture of X Ltd. would be (8/10.50) x100 = Rs76.19. NAV Q. No. 1 : A mutual fund scheme has 1m units outstanding. As on 31st March, 2007, its assets and liabilities regarding the scheme are as follows: (i) Market value of listed and traded shares and debentures: Rs.50m (ii) Unlisted shares: 10000 equity shares of Rs.10 each of ABC Ltd. EPS of ABC is Rs.10. PE ratio of a similar listed and traded company (say XYZ) is 12. (iii) Listed but not traded Debentures: 1000 debentures of ABC Company Ltd, face value Rs.1000, Annual coupon rate 9%. Yield to maturity of similar listed and traded debentures (say of XYZ) is 9.50%.

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(iv) Cash and Cash-Equivalent Rs.3m (v) Outstanding expenses Rs.0.10m

Answer The PE ratio of ABC would be less than that of XYZ because of illiquidity of shares of ABC. Lets assume that PE ratio of ABC = 11. Hence, MP of ABC = 11x10 =110. Market value of 10000 shares of ABC = Rs.11,00,000. The YTM of ABC would be more than that of XYZ because of illiquidity of debentures of ABC. Lets assume that YTM of ABC debenture is 10%. Market Value of debenture of ABC=[(90/1.10)+(90/1.102)+ 90 MV of 1000 debentures = 9,00,000

Assets : 50m (Listed)+1.10m(Unlisted)+ 0.90m(listed but not traded)+ 3m(cash) = 55m Liabilities : 0.10m (outstanding) 55m 0.10m NAV = ------------------ = Rs.54.90 1m RETURNS Q. No. 2 : A has invested in three Mutual Fund schemes as per details below: MF A MF B MF C Date of investment 1.12.03 1.1.04 1.3.04 Amount of investment Rs.50000 Rs.100000 Rs.50000 NAV on entry date Rs.10.50 Rs.10 Rs.10 Dividend recd. Up to Rs.950 Rs.1500 Nil 31.3.04 NAV as at 31.3.04 Rs.10.40 Rs.10.10 Rs.9.80 What is the effective yield on per annum basis in respect of each of the three schemes to Mr. A up to 31.3.04? (Nov. 2004) Answer No. of units purchased = 50000/10.50 = 4761.9048 Yield for 4 months (1.12.03 31.3.2004): (4761.9048 x 10.40) + 950 =--------------------------- - 1 = 0.009476 50,000

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Annual yield = 0.009476 x (12/4) = 0.02842 = 2.842857 Similarly, please make calculations regarding B & C

Q. No. 3 : A MF that had an NAV of Rs.20 in the beginning of the month made income and capital gain distribution of Re.0.0375 and Re.0.03 per share respectively during the month, and then ended the month with an NAV of Rs.20.06. Calculate the monthly return. (May, 2003) Answer Monthly return 20.06 + 0.0375 + 0.03 = ----------------------------- - 1 20

= 0.006375 = 0.6375%

Q. No. 4 : Mr. A can earn a return of 16% by investing in equity shares of its own. Now he is considering a recently announced equity based MF scheme in which initial expenses are 5.50% and annual recurring expenses of 1.50%. How much should the MF earn to provide Mr. A return of 16%. (Nov. 2003) Answer Answer Lets assume that the MF earns x% on its investments. (94.50)(x / 100) (94.50)(1.5/100) = 16 X = 18.43 Q. No. 5: Shri Brij Nandan can earn a return of 14% by investing in equity shares of its own. He invests his money in a new scheme of a mutual fund. The Fund is expected to have a ROI of 16%. The initial expenses of the fund are 5%. Find the rate of recurring expenses that will provide him the same % of return as he could by investing in equity shares of his own. Answer Lets assume that the rate of recurring expenses = x 14 = (95)(0.16) -95x x = 0.0126 x = 1.26% Q. No. 6 : A mutual fund has shown its NPV of 8.75 and 9.45 at the beginning and end of the year respectively. The Mutual fund has given two options: (a) Dividend of 0.75 per unit and Re.0.60 per unit as capital gain per unit (b) Reinvestment of these distributions when the NAV is Rs.8.65 per unit An investor purchased 300 units in the beginning of the year. Find his annual return under each of the two alternatives.(May,2006) .(May,2006) Answer (i) Annual return (cash payments) =[(9.45+.75+.60)/8.75] -1 = 0.2343 (ii) No. of units received against distributions = [300(.75 + .60)] / 8.65 = 46.82

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Annual return (reinvestment) = [{(9.45 x 346.82) / (300 x 8.75)}]-1 = 0.2486 Q. No. 7 : Mr. X on 1.7.2000, during the initial offer of some Mutual Fund invested in 10,000 units having face value of Rs.10 for each unit. On 31.3.2001 the dividend operated by the M.F. was 10% and Mr. X found that his annualized yield was 153.33%. On 31.12.2002, 20% dividend was given. On 31.3.2003 Mr. X redeemed all his balance of 11,296.11 units when his annualized yield was 73.52%. What are the NAVs as on 31.3.2001, 31.12.2002 and 31.3.2003? (Nov. 2006) Answer Teaching Note: Annualized Return = % Return from date of investment to the date on which annualized return is given or calculated --------------------------------------Period of the above return in terms of years 31.3.2001: Annualized Return

= Return from 1.7.2000 to 31.3.2001 / 0.75 year

153.33 = Return from 1.7.2000 to 31.3.2001 / 0.75 year Return from 1.7.2000 to 31.3.2001 = 115% It means the investment made on 1.7.2000 has grown to Rs.215000 on 31.3.2001 Let the NAV = y y = [10,000units + (Amount of dividend/y)].y = 215000 [10,000units + (Rs.10,000/y)].y = 215000 NAV = 20.50 Total no. of units = 10487.80 31.12.2002 No of units issued (reinvestment of dividend as on 31.12.2002): 11296.11- 10487.80 = 808.20 NAV = [10487.80 x Dividend per share ] /808.20 = [10487.80 x 2] /808.20 = 25.95 31.3.2003 Annualized Return = Return from 1.7.2000 to 31.3.2003 / 2.75 year 73.52 = Return from 1.7.2000 to 31.3.2003 / 2.75 year

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Return from 1.7.2000 to 31.3.2003 = 202.18 It means the investment of Rs.1,00,000 made on 1.7.2000 has grown to Rs.302180 on 31.3.2003. NAV = 302180 / 11296.11 = 26.75

Q. No. 8 : Sun Moon Mutual Fund (Approved Mutual Fund) sponsored open-ended equity oriented scheme Chanakya Opportunity Fund. There were three plans viz. A Dividend Reinvestment Plan, B Bonus Plan & C Growth Plan. At the time of Initial Public Offer on 1.4.1995, Mr. Anand, Mr. Bacchan & Mrs. Charu, three investors invested Rs. 1,00,000 each & chosen B, C & A Plan respectively. The History of the Fund is as follows: Date Div. % Bonus ratio 28.07.1999 31.03.2000 31.10.2003 15.03.2004 31.03.2004 24.03.2005 31.07.2005 20 70 40 25 40

5:4

1:3 1:4

Net Asset value per unit (FV Rs.10) Plan A Plan B Plan C 30.70 31.40 33.42 58.42 31.05 70.05 42.18 25.02 56.15 46.45 29.10 64.28 42.18 20.05 60.12 48.10 19.95 72.40 53.75 22.98 82.07

On 31st July all three investors redeemed all the balance units. Calculate annual rate of return to each of the investors. Consider: 1. Long-term Capital Gain is exempt from Income tax. 2. Short-term Capital Gain is subject to 10% Income tax. 3. Security Transaction Tax 0.2 per cent only on sale/redemption of units. 4. Ignore Education Cess and surcharge. (Nov. 2005) Teaching Note: Annualized Return = % Return from date of investment to the date on which annualized return is given or calculated _________________________________________________ Period of the above return in terms of years Answer Plan C Investment Redemption

10,000 Units @ Rs.10.00 each = 10,000 Units @ Rs.82.07 each =

Rs.1,00,000 Rs.8.20,700

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Security Transaction Tax = 8,20,700 x (0.2/100) = Rs.1641.40

Net redemption Proceeds = Rs.8,20,700 Rs.1641.40 = Rs.8,19,058.60 Period of investment: 10.33 years. % return = [(819059 / 100000) - 1 = 7.19059 = 719.059 % Annualized Return = 719.059 / 10.33 = 69.61

Plan B: No. of units on 1.4.95 Bonus units received on 31.3.2000 Total units after bonus on 31.3.2000 Bonus units on 31.3.2004 Total units after bonus on 31.3.2004 Bonus units on 24.3.2005 Total units after bonus on 24.3.2005

10,000 12,500 22,500 7,500 30,000 7,500 37,500

Redemption proceeds = 37500 x 22.98 = Rs.8,61,750 Short term capital gain = 7500 ( 22.98 ) = Rs.172350 S.T. capital gain tax (ignoring surcharge and education cess) = Rs.17,235 STT = 0.2% of Rs.8,61750 = 1724 Net realization = Redemption proceeds minus STCG tax minus STT = 861750 17235 -1724 = Rs.8, 42,791 Holding period return (%) = [(842791/100000) - 1 = 7.4291 = 742.91% Annualized Return = 742.91 / 10.33 = 71.92 % Plan A : Date

Div. per unit

Total dividend

No. of units allotted on a/c of dividend amount 651.4658 1,276.2797 1,131.1280 702.8456 1,144.4257

Total no. of units 10,000 10,651.4658 11,927.7455 13,058.8735 13,761.7191 14906.1448

1.4.95 28.7.99 31.3.00 31.10.2003 15.3.2004 24.3.2005

Rs.2 Rs.7 Rs.4 Rs.2.50 Rs.4

Rs.20000 Rs.74560.26 Rs.47710.98 Rs.32,647.18 Rs.55046.8764

Redemption proceeds = 14906.1448 x 53.75 = Rs.801205 STT: 1602 Short term capital gain = 1144.4257 [(53.75 48.10] = 6466 S.T. capital gain tax (ignoring surcharge and education cess) = 647 Net realization: Redemption proceeds minus STCG tax minus STT = 801205 647 -1602 = 7,98,956

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Holding period return (%) = [(798956 / 100000)-1] = 698.956 % Annualized Return = 698.956 / 10.33 = 67.66 %

Note: STT is not considered for calculating short term capital gain: Section 48, Income Tax Act, 1961. Q. No.9: Suppose you make a survey of performance of 100 Mutual fund managers and rank them by return on investment during the year 2007. 20 of them are really intelligent and skilled. They always fall in top 40%. The others fall in top 40% just by luck. How many managers, who were in top 40% this year, would you expect to be in top 40% in 2008? Answer 20 + 20(20/80) = 25 Q. No.10. You are considering investing in one of following 2 NFOs of 2 Mutual funds, issue price per unit = Rs.10. A: Entry load 2.25%. No exit load. B: Entry Load 0.90%, Exit load as per the flowing table:

Redemption on or before the expiry of 1 year 0.50% Redemption after the expiry of 1 year but before the expiry of 2 0.40% years Redemption on or after the expiry of 2 year but before the expiry of 0.30% 3 years Redemption on or after the expiry of 3 year but before the expiry of 4 0.20% years Redemption on or after the expiry of 4 year 0.10% In which MF you will invest if your time horizon of the investment is 1 year? 4 years? Assume that rate of ROI of the mutual fund will be 12% per annum (Net of expenses). Answer Let the time of horizon of investment = 1 year A Initial Investment Rs.10.225 Value at the end of 1 year Rs.10(1.12) = Rs.11.20 Annual Return(%) (11.20/10.225) 1 = 0.09535 = 9.535% B Initial Investment Value at the end of 1 year Annual Return(%)

Rs.10.09 10(1.12)- Exit Load =11.20 11.20( 0.50/100) =11.144 (11.144/10.09) 1 = 0.10446 =10.446%

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Investment in B is recommended. Let the time of horizon of investment = 4 year A Initial Investment Rs.10.225 Value at the end of 4 years Rs.10(1.12)4 = Rs.15.7351 Holding period Return(%) (15.7351/10.225) 1 = 53.89% Annual return 53.89/4 = 13.4725% B Initial Investment Value at the end of 4 years Holding period Return(%) Annual return

Rs.10.09 Rs.10(1.12)4 exit load = 15.7351 15.7351( 0.10/100) = 15.72 (15.72/10.09) 1 = 55.80 % 55.80/4 = 13.95 %

Investment in B is recommended.

Q. No. 11 : The NAV of a mutual fund scheme is Rs.15. The entry load is 2.25 %. What amount of investment is required to purchase 100 Units. Answer 100 x 15( 1.0225) = 100 x 15.3375 = 1533.75

Q. No. 12 : Govind invests Rs.1000 in a mutual fund the entry load of which is 2.25%. He got 50 units. What is the NAV at the time of investment? His investment time horizon is 6 months. The mutual Fund charges exit load of 0.50% if the redemption is done on or after the 6 months but on or before 1 year. What is annualized return to the investor if gets his investment redeemed on expiry of 6 months assuming that NAV at that time is Rs.25 per unit. . Answer Gross cost per unit at the time of investment Let NAV at the time of investment = X X(1.0225) = 20 X = 19.5599 NAV at the time of investment Gross redemption proceeds Net Redemption proceeds Holding period Return(%) Annualized rate of return 1000/50 = Rs.20

Rs.19.5599. 25x50 = 1250 1250 1250(0.50/100) = 1250 6.25 = 1243.75 (1243.75/1000)-1= 24.375 24.375/0.50 = 48.75%

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Q. No.13: A close-ended mutual fund is listed at BSE. Its market price is Rs.50 per unit. The assets under the management of the mutual fund are worth Rs.480m and the liabilities are Rs.1m. The numbers of units outstanding are 10m. What is NAV of the Unit of the MF? What is the premium or discount over NAV? Answer NAV = (480m 1m) / 10m = 47.90 The market price = Rs.50. Premium on NAV = 2.10 % of Premium on NAV = (2.10/47.90)x 100 = 4.38% Q. No. 14 : Shri Abhay Charanji invested Rs.1,000 in a close ended MF, the NAV at the time of investment was Rs.15 and it was being trade in the Stock Exchange at a premium of 1%. During the year the fund paid a dividend of Rs.2 Per unit. The investor sold the investment in the stock exchange after receiving the dividend.. His return is 20% p.a. Assume that at the time of sale in the stock exchange, i.e. six months after the date of investment, the units were being traded in the market at 2% discount. What was the NAV at the time of sale? Answer No. of units Purchased = 1000 / 15.15 = 66.0066 Total investment = 1000. Return of 20% p.a. Return in six months = 10%. The wealth at the end of 6 months period = Rs.1,100. Dividend in cash = 2 x 66.0066 = 132 Sale proceeds of 66.0066 units = 1100 -132 = Rs.968 Sale proceeds per unit = 968 / 66.0066 = 14.67 Let NAV = X X .02X = 14.67 X = 14.96 Q. No. 15 : An investor invests in a MF, having 1m units outstanding, in the beginning of the year. During the year the fund received the Dividend of Rs.1m. The fund neither purchased nor sold any investment during the year. The investments of the MF appreciated by 10 % during the year (exclusive of dividend). The year end NAV is Rs.40. Find the NAV in the beginning of the year. What is the investors rate of return? Answer Let NAV in the beginning of the year = X. Year end NAV = 40 Year end NAV = [(1.10m) X + 1m] / 1m = 40 [(1.10m) X + 1m] = 40m (1.10m)X = 39m X = 35.4545 Investors rate of return = [(40/35.4545) 1]x100 = 12.82%

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Q. No. 16 : Nand Nandan purchased 200 units of a MF scheme having entry load of 2.25%. The total cost of this investment was Rs.50,000. The investments of the mutual fund appreciated by 15% during the year. The expense ratio is 1.50% of net investment. Assuming that he disinvested the units at the end of the year, what is rate o f return on the investment. Answer Cost per unit purchased = 50000/200 = Rs.250 NAV at the time of purchase = 250/1.0225 = 244.4988 NAV at the end of the year = (244.4988x200x1.135) / 200 = Rs.277.51 Q. No. 17 : Your time horizon of the investment is 2 years. You can deposit your money with SBI to give a return of 8% annually compounded. Alternatively you can invest in a mutual fund charging an entry load of 2.25%. Expense ratio is 1% of net investment in the beginning of the year. What the rate of return on the investment should the mutual fund earn so that you are better off than the Bank fixed deposit? Answer Time Horizon = 2 years Net investment = 97.7995 Let the MF earns X% on its investments. Expense ratio = 1%. Net return = (X-1) % = 0.01X 0.01 97.7995(1 + 0.01X 0.01)2 = 100(1.08)2 (1 + 0.01X 0.01)2 = 1.192644 1 + 0.01X 0.01 = 1.09208 0.01X = 0.10208 X = 10.208% CRITERIA FOR EVALUATION OF MUTUAL FUNDS / PORTFOLIO PERFORMANCE Likely Return - RF = -------------------------SD This ratio measures the risk premium earned per unit of total risk. (Higher, Better). This is also known as reward to variability ratio. SHARPE RATIO To comment on the individual portfolio, we compare Sharpe ratio of the portfolio with that of the market.

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Q. No.18: Calculate Sharpe Ratio on the basis of following data given regarding 4 portfolios: Portfolio A B C D Expected rate of return 11% 14% 10% 15% SD of returns from portfolios 6.00 7.50 3.00 9.00 with a SD

The expected return on market portfolio is 8.50 percent of 3. The RF is 5 per cent. Which portfolio has performed the best?

Teaching Note: Expected return v/s likely return: The term expected return, in RISK AND RETURN chapter, is used to convey two meanings: (I) Likely return i.e. what an investor is likely to get i.e. the investor hopes to get ( It is estimated on the basis of past returns) It is also referred as average return.

(II) Expected return i.e. i.e. what an investor deserves to get in view of risk he has taken (it is equal to RF + RISK PREMIUM) It is also called as required return.
Answer SHARPE RATIO LIKELY RETURN RF = ----------------SD Portfolio Sharpe ratio A (11-5)/6.00 = 1.0000 B (14-5)/ 7.50 = 1.2000 C (10 -5)/3.00 = 1.6667 D (15-5 )/9.00 = 1.11 Hence, C is best performer. Likely Return - RF ----------------Beta This ratio measures the risk premium earned per unit of systematic risk. (Higher, Better).The ratio is also known as reward to volatility ratio. TREYNOR RATIO = To comment on the individual portfolio, we compare Treynor ratio of the portfolio with that of the market.

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Q. No.19: Calculate Treynor Ratio on the basis of the results of four portfolio managers for a 5-years period given below: (RF 10%, RM 16%) Portfolio Average Return (%) Beta Manager Warren 14 0.80 King 17 1.05 Tony 17 1.25 Gates 15 0.90 Select the manager with best performance. Answer Treynor ratio = LIKELY RETURN RF BETA Portfolio Treynor ratio A (14-10)/0.80 = 5.0000 B (17-10)/1.05 = 6.6667 C (17-10)/1.25 = 5.6000 D (15-10)/0.90 = 5.5555 B is best performer. JENSONS ALPHA = Likely Return [RF + Beta(RM-RF)] The ratio measures the excess return earned over the expected return. (By expected return we mean, the return that should be earned considering the risk that has been undertaken). If Jensons Alpha is positive, the performance is satisfactory, otherwise it is not. Q. No.20: Calculate Jensons Alpha on the basis of the results of four portfolio managers for a 5-years period given below: (RF 10%, RM 16%) Portfolio Manager Average Return (%) Warren 14 King 17 Tony 17 Gates 15 Select the manager with best performance. Answer JENSONS ALPHA Portfolio A B C D B is best performer. Beta 0.80 1.05 1.25 0.90

= Likely return [RF + Beta(RM-RF)] Jensons Alpha 14-[10+0.80(16-10)] 17-[10+1.05(16-10)] 17-[10+1.25(16-10)] 15-[10+0.90(16-10)]

= -0.80 = 0.70 =-0.50 =-0.40

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Teaching Note: For a well diversified mutual fund (scheme), Treynor ratio is an appropriate ratio for performance evaluation. There are two reasons for the same: (i) In such mutual funds, there is almost negligible unsystematic risk (because of diversification). Systematic risk is taken care of by Treynor Ratio. (ii) This ratio considers Market S.D. as well as coefficient of correlation (for calculation of Beta). These are ignored by Sharpe Ratio. For Comparing mutual funds of almost similar types, Jensons Alpha may be used. For other cases, Sharpe ratio is quite appropriate as it takes care of total risk.

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EXTRA PRACTICE ( MUST DO ) Q. No. 21 : On 1.8.2005, Meera invested Rs.1,00,000 in 10,000 units having face value of Rs.10 for each unit under dividend reinvestment plan. On 31.3.2006 the dividend declared by the M.F. was 10% and Meera calculated that her annualized yield was 120%. On 31.10.2006, 15% dividend was given. On 31.12.2006 Meera redeemed all her balance of 12,000 units when his annualized yield was 180%. What are the NAVs as on 31.3.2006, 31.10.2006 and 31.12.2006? Answer 31.3.2006 Total value of units = Rs.1,80,000 Value of units received on reinvestment of dividend = Rs.10,000 Value of other 10000 units = Rs.170,000 NAV per unit = Rs.17 Total no. of units = 10000 + 10000/17 = 10588.2353 31.10.2006 Dividend = 10588.2353X1,50 = Rs.15,882.35 No. of units = 1,411.7647 NAV = 15882.35/1411.7647 = 11.25 31.12.2006 Total value of 12,000 units NAV

= Rs.3,55,000 = Rs.29.5833

Q. No. 22 22: A US mutual fund announces a new Mutual fund offer, details as follows : Invest $10,000 on your birthday every year for 20 years. Receive annuity on your birthday every year for next 20 years. Rate of return is 10% p.a. What is the amount of annuity? Answer: Answer Amount invested in the beginning of the first year will be repaid (along with interest) st in the beginning of the 21 year, amount invested in the beginning of the second nd year will be repaid (along with interest) in the beginning of the 22 year, and so on. Annuity or amount to be paid on each birthday for 20 years beginning with 21 20 birthday = $10,000(1.10) = $67,116
st

Q. No. 23 : Gopika invested Rs.10,000 in the New Fund Offer of a close ended Scheme of Vaibhav Mutual fund. The fund is listed in a stock exchange. Consider the following details:

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End of the year 1 2 3 4 5 NAV 10.90 12.00 14.00 15.70 18.90 Market price as a % of Discount or premium over the NAV -0.20 -0.10 +0.20 +0.30 +0.50

(a) Calculate the annualized return if her time horizon is 5 years. (b) What is the annually compounded growth rate in NAV over 4 years? (c) Calculate the % annual return of a person who invested in the scheme at the end year and disinvested at the end of the 2nd year. of 1st (d) What is the annually compounded growth rate of return of person who invested at the end of 1st year and disinvested at the end of 5th year? Answer (a) Realization at the end of 5 years = 18.90 + 18.90(0.50/100) = 18.9945 Holding period return = [(18.9945 10) /10] x 100 = 89.945 %. Annualized return = 89.945/5 = 17.989% (b) Annually compounded growth rate (ACGR) in NAV 1/4 = [(15.70/10.00) ] 1 = 11.94% (c) Purchase cost = 10.90 10.90(0.20/100) = 10.8782 = Redemption = 12 12 (0.10/100) = 11.988 = Annual return = [(11.988 /10.8782)] 1 = 10.20% (d) Cost at the end of I year : 10.8782 Redemption value at the end of 5th year=18.90+18.90(0.50/100)=18.9945 ACGR = [(18.9945/10.8782) ] -1 = 14.95% Q. No. 24 24: Hari invested Rs.1,00,000 in 10,000 units of MAHALAXMI Mutual Fund on 1.4.2005 under Dividend payment plan. The mutual fund paid a dividend of Rs,15,000 during the year ended 31st March, 2006. The NAV on 31st March, 2006 was Rs.14 per unit. On 31st March, 2007, the mutual fund paid a dividend of Rs.2 per unit. The mutual fund announced that during the year ended 31st March, 2007, it has provided a return of 40% to its investors. Find the NAV as on 31st March, 2007 (after the payment of dividend. Answer Return = Wealth ratio 1 Let NAV on 31st March, 2007 = x 0.40 = [(x+2) / 14] 1 1.40 = (x+2) / 14 19.60 = x + 2 x = Rs.17.60
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17 EXTRA PRACTICE QUESTIONS ( OPTIONAL)

Q. No. 25 Given the following details regarding Blue-chip Mutual Fund Portfolio scheme and market portfolio, measure the performance of the portfolio under each of the following three assumptions; (RF = 10%) (a) its a well diversified Mutual Fund portfolio scheme (b) it is a sector specific Mutual fund portfolio scheme (c) it is neither a nor b Return Beta SD Answer Blue-chip portfolio 40% 1.40 30% Market 30% ? 20%

Return RF 40 - 10 (a) Trenyor Ratio of portfolio = ----------- = -------- = 21.43 Beta 1.40 Return RF 30 - 10 Trenyor Ratio of market = ----------- = -------- = 20 Beta 1 The performance of the portfolio is satisfactory its Trenyor ratio exceeds that of the market. (b) JENSONS ALPHA of portfolio = Return [RF + Beta(RM-RF)] = 40 [10 + 1.40(30-10)] = 2 As Jensons Alpha of the portfolio is +, the performance of the portfolio is satisfactory. (c) SHARPE RATIO = RETURN RF 40 - 10 ------------ = ---------- = 1 SD 30

30 - 10 Sharpe ratio of the market = --------------- = 1 20 The performance of the mutual fund matches with the market i.e. the performance is neutral. Q. No. 26: 26 A mutual fund holds 300 equity shares of Madan Gopalji Ltd. The share is currently quoted at Rs.67. 1 month call on this share, with a strike of Rs.75.00, is being quoted in the market at Rs3.00 per share. The mutual fund manager intends to sell all the 300 shares if the price hits at Rs.75.00. What is your comment/suggestion?

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Answer The manager may write call with exercise price of Rs.75. Option premium receipt Rs.900. This is income for the mutual fund. Now two mutually events will happen: If the market price is Rs.75 or more, the realization will be Rs.75 per share (this is in addition to the premium already received by the mutual fund) If the market price is less than Rs.75, the MF will continue to hold the shares as the manager does want to sell shares for less than Rs.75. (The premium has already been received by the mutual fund)

Q. No. 27: 27: A US Mutual Fund announces a New Fund Offer (Open ended). The investors are given three mutually excusive schemes: (I) Entry load of 2% of the face value of the USD 10. (II) Annual fees of 1%. To charge this fee, the number of units held by an investor would be reduced by 1% (of the number of the units purchased) at the end of each year. The investor can avoid this fee by redeeming his holding before the date of the year end. (III) The Exit load of 3% of NAV at the time of redemption of the units by the investor. Which scheme would you suggest to a client assuming that his time horizon is 4 years and that the NAV is expected to grow at an annual compounded rate of 15%? Answer (i) NAV at the end of 4th year: [10(1.15) ] =17.4901. Annually compounded growth rate of return = [(17.4901/ (10.20) (ii)
1/4 4

] 1 = 14.43 %

Annually compounded growth rate of return = [(17.4901 x 0.96) / (10)]

1/4

-1 = 13.8324 %

(iii)

Annually compounded growth rate of return = [(17.4901 x 0.97) / (10)]

1/4

-1 = 14.1277 %

I scheme is recommended. Q. No. 28: 28: An investor purchased 1000 units of a MF at the rate of Rs.27.53 per unit. At the year end, the MF announced a dividend of Rs.2.00 per unit and after that the NAV was Rs.39.05. The investor has opted for Reinvestment of

19
Dividend scheme. Find the number of units held by the investor at the end of the year. What is the % return? What would have been the % return had he opted for the payment of dividend in cash scheme? Answer No. of units = 1000 + (2000/39.05) = 1051.2164 Annual return = [(1051.2164 x 39.05) / (1,000 x 27.53)] 1 = 49.1101% Annual return (Dividend in cash) = [39050 + 2000]/27530 - 1=49.1101%

Q. No. 29 : Murali has been contributing Rs15,000 per year to each of the following two schemes of a Mutual fund for getting post retirement annuity; (i) Debt fund (ii) Equity Fund. The current value of each of the two investments Rs.1m. She plans to retire after 25 years from today and her life expectancy is 15 years after the retirement. The debt fund is expected to earn 3% p.a. perpetually while the expected return on the equity fund is 6% p.a. perpetually. What shall be her retirement annuity? She is planning to increase her annual contribution to the debt fund so that she may get a total annuity, from both the funds, of Rs.8,00,000. Calculate the increase in the annual contribution. You can make appropriate assumption. Answer Present value of funds accumulated after 25 years ( debt fund)

15000[(1.03)25+(1.03)24++(1.03)1 ] 10,00,000+ -----------------------------------25 [(1.03) 1 1 1 10,00,000+ 15,000 [ 1 + ----- + -------+ +------] 1 2 24 (1.03) (1.03) (1.03) 10,00,000 + 15000[ 1 + 16.9355] = 12,69,033 12,69,033 Annuity = ------------------------------1 1 ------ + +----25 39 (1.03) (1.03)

20
12,69,033 Annuity = ------------------------------------------1 1 1 --------- x[------ + +-----] 24 1 15 (1.03) (1.03) (1.03) 12,69,033 Annuity = ----------------------------- = 2,16,107 (0.4919)(11.9379) Present value of funds accumulated after 25 years ( equity fund) 1 1 1 10,00,000+ 15,000 [ 1 + ----- + -------+ +------] 1 2 24 (1.06) (1.06) (1.06) 10,00,000 + 15000[ 1 + 12.5504] = 11,88,256 11,88,256 Annuity = ------------------------------------------1 1 1 --------- x[------ + +-----] 24 1 15 (1.06) (1.06) (1.06) 11,88,256 Annuity = ----------------------------- = 495334 (0.2470)(9.7122) Total annuity from existing funds 2,16,107 + 4.95,334 = 7,11,441 Target annuity 8,00,000 Short fall 88559 Let she invests Rs.x annually for 25 years in debt fund to get the annuity of Rs.88,559. 88559 = x(17.9355) / 5.87225 = 28,995 Murali should invest Rs. 28,995 annually for 25 years, in debt fund, to get the additional amount of annuity. If this action is taken, she will get the annuity of Rs. 8,00,000 for 15 years after her retirement.
Q. No. 30 : Mr. X earns 10% on his investments in equity shares. He is considering a recently floated scheme of a Mutual Fund where the initial expenses are 6% and annual recurring expenses are expected to be 2%. How much the Mutual Fund scheme should earn to provide a return of 10% to Mr. X? (June 2009 SFM)

21 Answer
Let the MF earns x% on its investments. Let the investor invests Rs. 100 10 = 94.x/100 94(2/100) 10 = .94x 1.88 x = 12.64% Q. No. 31 : A mutual fund made an issue of 10,00,000 units of Rs.10 on January 1, 2008. No entry load was charged. It made the following investments: Rs. 50,000 equity shares of Rs. 100 each@160 80,00,000 7% Government securities 8,00,000 9% Debentures (unlisted) 5,00,000 10% Debentures ( Listed ) 5,00,000 98,00,000 During the year, dividends of RS. 12,00,000 were received on equity shares. Interest on all debt securities are received as and when due. At the end of the year equity shares and 10% debentures are quoted at 175% and 90% respectively. Other instruments are at par. Find out NAV per unit given that operating expenses paid during the year amounted to Rs.5,00,000. Also find out the NPV if the Mutual fund had distributed a dividend of Rs. 0.80 per share during the y4ar to the unit holders. (Nov. 2009) Answer Calculation of NAV if No dividend was paid: Cash Un-invested cash Rs. 2,00,000 Dividend received 12,00,000 Interest on 7% GS 56,000 Interest on 9% Debentures 45,000 Interest in 10% Debentures 50,000 Expenses - 5,00,000 Cash in hand Rs.10,51,000 Net assets of the MF : Cash 10,51,000 Equity shares 87,50,000 7% GS 8,00,000 9% Debentures 5,00,000 10% Debentures 4,50,000 Total 1,15,51,000 NAV = Net assets / No. of units 1,15,51,000 / 10,00,000 = 11.551 NAV in case of dividend = NAV without dividend Dividend per unit = 11.5510 0.8000 = 10.7510

22
Q. No. 32: 32: Mr. Sinha has invested in three Mutual Fund schemes as per details below: MF A MF B MF C Date of investment 1.12.08 1.1.09 1.3.09 Amount of investment Rs.500000 Rs.100000 Rs.50000 NAV on entry date Rs.10.50 Rs.10 Rs.10 Dividend recd. Up to Rs.9500 Rs.1500 Nil 31.3.04 NAV as at 31.3.04 Rs.10.40 Rs.10.10 Rs.9.80 What is the effective yield on per annum basis in respect of each of the three schemes to Mr. Sinha up to 31.3.09? (Nov. 2009)

Answer MF A No. of units purchased = 500000/10.50 = 47619.048 Yield for 4 months (1.12.08 31.3.2009): (47619.048 x 10.40) +9500 =--------------------------- - 1 = 0.009476 5,00,000 Annual yield = 0.009476 x (12/4) = 0.02842 = 2.842857 MF B No. of units purchased = 100000/10 = 10,000 Yield for 3 months (1.01.09 31.3.2009): (10000 x 10.10) +1500 =--------------------------- - 1 = 0.025 = 2.50% 1,00,000 Annual yield = 2.50 x 12/3) = 10% MF C Yield for 1 months (1.01.09 31.3.2009): (5,000 x 9.80 =--------------------------- - 1 = 0.02= -2% 50,000 Annual yield = -2 x (12/1) = 24%
Q. No No.33 T Ltd has prompted an open-ended equity oriented scheme in 1999 with two plans- Dividend Reinvestment Plan ( Plan A) and a Bonus Plan ( Plan B); the face value of units was Rs. 10. X and Y invested Rs. 5,00,000 each on 1.4.2001 respectively in Plan A and Plan B, when the NAV was Rs.42.18 for Plan A and Rs.35.02 for Plan-B. X and Y both redeemed their units on 31.3.2008. Particulars of dividend and bonus over the period are as follows:

23
Date 15. 9.2001 28. 7.2002 31. 3.2003 31.10.2003 15. 3.2004 24. 3.2005 27. 3.2006 28. 2.2007 31. 3.2008 Dividend (%) 15 20 18 16 12 Bonus 1:6 1:8 1:11 1:12 Plan A 46.45 42.18 48.10 49.60 52.05 53.05 54.10 55.20 50.10 NAV Plan B 29.10 30.05 34.95 36.00 37.00 38.10 38.40 39.10 34.10

You are required to calculate the annual return for X and Y after taking into consideration the following information: (i) Securities Transaction tax @ 2% on redemption (ii) Liability of capital gain to income tax (a) Long term exempt (b) Short- term capital gains at 10% plus education cess at 3%.(Nov. (Nov. 2008)

Answer
(a) Note: Securities transaction tax has been taken at 2% (as given in the question). (b) Short-term capital gain is not applied as all the units (including the units allotted on 28.2.2007) have been owned for more than 12 months. PLAN A : No of units purchased : 5,00,000 / 42.18 =11,853.9592 Date 1.4.2001 15.9.2001 31.3.2003 15.3.2004 27.3.2006 28.2.2007 Dividend NAV No. of units allotted against dividend 382.7974 508.8048 440.7687 389.9839 295.1373 Total No. of units 11,853.9592 12,236.7566 12,745.5614 13,186.3301 13,576.3140 13,871.4513

17780.9388 24473.5132 22,942.0152 21098.1282 16,291.5768

46.45 48.10 52.05 54.10 55.20

Net redemption proceeds = 13,871.4513 x 50.10 x .98 = 6,81,061 Annual return = Holding period return/ holding period in terms of no. years = (1,81,061/5,00,000)/8 = 4.53% PLAN B : No of units purchased : 5,00,000 / 35.02 = 14,277.5557 Bonus = 2,379,5926 Bonus = 2,082.1435 Bonus = 1,703.5720 Bonus = 1,703.5720 Total 22.146.4378 Net redemption proceeds = 22,146.4378 x 34.10 x 0.98 = 7,40,090

24
Annual return = Holding period return/ holding period in terms of no. years = (2,40,090/5,00,000)/8 = 6.0023% Q. No. 34: 34 A mutual fund that had a net asset value of Rs.16 at the beginning of a month, made income and capital gain distribution of Rs.0.04 and Rs.0.03 respectively per unit during the month, and then ended the month with a net asset value of Rs.16.08. Calculate monthly and annual rate of return. (June 2009) Answer 0.04 + 0.03 + 16.08 Monthly return = ------------------ -1 = 0.9375% 16 ANNUAL RATE OF RETURN = 11.25% Q. No. 35 : A mutual fund has a NAV of Rs.20 on 1.12.09. During December, 2009, it has entered a regular income of Re.0.0375 and capital gain of Re.0.03 per unit. On 31.12.09, the NAV was 20.06. Calculate the monthly return and annual return. Answer: (Assumption Regular income of Re.0.0375 and capital gain of Re.0.03 have been distributed to the investors and NAV of 20.06 is after these distributions.) 0.0375 + 0.03 + 20.06 Monthly return = ---------------------- -1 = 0.006375 = 0.6375% 20 Annual return = 0.6375 x 12 = 7.65% Q. No. 36 (May, 2010) Based on the following information, determine the NAV of the regular income scheme on per unit basis: Rs. Crores Listed shares at cost (Ex-dividend) 20 Cash in hand 1.23 Bonds and debentures at cost 4.3 Of these, bonds not listed and quoted 1 Other fixed interest securities at par 4.5 Dividend Accrued 0.8 Amount payable on shares 6.32 Expenditure incurred 0.75 No. of units (Rs.10 Face Value) 20 Lakhs Current lrealizable value of fixed income securities of 106.5 face value Rs.100 The listed shares were purchased when index was 1000. present Index is 2300. Value of listed bonds and debentures at NAV date 8

25
There has been a diminution of 20% in unlisted bonds and debentures. Other fixed interest are at cost. Answer Note: Current realizable value of fixed income securities = Rs.106.50. It is assumed that it includes accrued interest of Rs.6.50.

Assets: Assets Listed shares Cash Listed Bonds Unlisted Bonds Fixed income securities ( including interest accrued) Div. accrued Total Liabilities Amount payable on shares Expenses Accrued Total Net Assets NAV = 54.5525/0.20 = 272.7625

Rs. Crores 46.00 1.23 8.00 0.80 4.7925 0.8000 61.6225 Rs. Crores 6.32 0.75 7.07 Rs.54.5525Crores

THEORETICAL ASPECTS Q. No No.37: .37: What is a Mutual Fund? Explain the different types of schemes of the mutual funds. Answer A MUTUAL fund is an organization (in India this organization must be in the form of a trust) that pools the savings of a number of investors called as unit holders who share a common goal. The money thus collected is invested by the professional fund managers in different types of securities depending upon the objectives of the scheme. The return/ loss on investment is shared by the unit holders in proportion to the number of units owned by them. A mutual fund is an ideal investment vehicle in today's complex financial scenario. Price changes in the financial assets are driven by so many events (including events taking place in other countries). An ordinary investor is unlikely to have the

26
knowledge, skills and time to understand the implication of these events and to act speedily. It is also difficult for him to keep track of various investments. Investment in mutual funds takes care of all these problems. A mutual fund offers an opportunity to invest in a diversified and professionally managed portfolio at a relatively low cost. When one invests in a mutual fund, there is no guarantee that he will have a positive income only, he may end with even with a loss because sometimes there are volatile fluctuations in the prices of investments, even professionals may not be able to protect the unit holders money. MUTUAL MUTUAL FUND SCHEMES There are wide varieties of mutual fund schemes that cater to needs of investors of different age-groups, having different financial positions, risk tolerance and return expectations. Each scheme has a pre-determined objective. On the basis of their structure, all mutual fund schemes can be divided into 2 categories: (1) Open-ended (2) Close-ended. An open-ended scheme is one that is available to subscription all through the year. These schemes do not have a fixed maturity. Investors can conveniently buy and sell units at net asset value based price at any time. The key feature of this type of scheme is liquidity. A close-ended scheme has a stipulated maturity period. The fund is open for subscription for a limited period only. Generally, units of such schemes are quoted on the stock exchanges. This is the exit route for those who want to go out and entry route for those who want to invest after the subscription period is over.

The other types of schemes are: (1) Tax saving schemes, (2) Sector specific schemes, and (3) Index-based schemes. Tax saving schemes is meant for those who want to save income tax under section 80C of Income-tax Act, 1961. SBI Magnum Taxgain, Fidelity tax Advantage etc are the examples of such schemes in India. Sector specific schemes invest only in the equity shares of a particular sector, i.e., IT fund, pharma fund, fast moving consumer goods (FMCG) fund, etc. Index fund invests their funds in the equity shares included in an index like BSEs Sensex, NSE's Nifty or some other Index. Examples are: HDFC Index Sensex, UTI Nifty Index Franklin India Index BSE Sensex. Q. No No.38: .38: Explain the regulation of the mutual funds by the SEBI. Answer REGULATION OF MUTUAL FUNDS IN INDIA In India, mutual funds are regulated by SEBI. Money market mutual funds are also regulated by RBI. Important regulations of SEBI are as follows:

27

Mutual Fund Structure MF must be in the form of trust. It should be registered with SEBI. MF is established by a sponsor having a sound record and experience. The sponsor should appoint a trustee-company or a Board of Trustees. If a company is appointed as trustee, its Board of Directors will constitute the Board of Trustees for the trust. 2/3 members of the Board of Trustees should be independent persons, not related to sponsors. The sponsor/Board of trustees should appoint an Asset Management company (AMC) as investment manager of the MF trust. Sponsor should hold at least 40 per cent of net worth of the AMC. The minimum net worth of the AMC should be Rs. 10 crore. The AMC should be registered with SEBI. The sponsor/Board of Trustees should appoint (i) a SEBI registered custodian for safe custody of the assets of the MF, and (ii) a registrar to handle the registry work of the unit holders. Other Important Regulations Before launching any scheme, it should be approved by the Board of Trustees and a copy should be filed with SEBI along with filing fees. The offer document shall contain such disclosures which are adequate in order to enable the investors to make informed judgment. The advertisements issued by the MF should not be misleading. It should not contain any incorrect or false statement. A mutual fund scheme should not invest more than 15 per cent of its NAV in debt instruments issued by a single issuer which are rated below investment grade by any credit agency (approved by SEBI). No MF under its all schemes should own more than 10 per cent of any company's voting right shares. The initial issue expenses in respect of any close-ended scheme may not exceed 6 per cent of funds raised under that scheme. Such expenses should be amortized on weekly basis over the life of the scheme. The recurring expenses are subject to following limits: First Rs. 100 crore : 2.50 per cent of weekly of average net assets. Next Rs. 300 crore : 2.25 per cent of weekly average net assets. Next Rs. 300 crore : 2 per cent of weekly average net assets. On the balance : 1.75 per cent of weekly average net assets. ------------A MF may invest up to $ 300 million in overseas listed securities. (all the Mutual funds can invest up to $ 7 Billion per year in overseas listed securities ) Proper accounts should be maintained and get audited. Financial year should be followed as accounting year. Scheme wise annual report should be sent to the investors. A copy should be sent to SEBI within 6 months of end of financial year.

Q. No. 39: 39: Explain, how to establish a Mutual fund. ( Nov. 2003) Answer (1) MF must be in the form of trust. It should be registered with SEBI.

28
(2) (3) MF is established by a sponsor having a sound record and experience. The sponsor should appoint a trustee-company or a Board of Trustees. If a company is appointed as trustee, its Board of Directors will constitute the Board of Trustees for the trust. 2/3 members of the Board of Trustees should be independent persons, not related to sponsors. The sponsor/Board of trustees should appoint an Asset Management company (AMC) as investment manager of the MF trust. Sponsor should hold at least 40 per cent of net worth of the AMC. The minimum net worth of the AMC should be Rs. 10 crore. The AMC should be registered with SEBI. The sponsor/Board of Trustees should appoint (i) a SEBI registered custodian for safe custody of the assets of the MF, and (ii) a registrar to handle the registry work of the unit holders.

(4)

(5)

Q. No. 40 (i) who can be appointed as Asset Management company (AMC)? ? (ii) Write the conditions to be fulfilled by an AMC. (iii) What are the obligations of AMC? ( May, 2005) Answer (i) A company, incorporated under companies Act, 1956, registered with SEBI to work as an asset management company can be appointed as Asset Management company to manage the investments of a Mutual fund. (ii) Conditions to be fulfilled: (i) (ii) (iii) (iv) (v) Minimum net worth Rs. 10 Crores good reputation Directors have the knowledge about capital market At least 50% directors should be independent Chairman of the AMC should not be the trustee of the MF trust.

(iii) Obligation: (i) (ii) (iii) (iv) (v) (vi) Due care of investment Follow code of conduct prescribed by SEBI To see that (a) SEBI regulations regarding MFs and (b) the provisions regarding the trust deed are not violated Responsible for the omissions and commissions of the employees Quarterly report regarding the investment activities to sponsors Should declare the investments made by its key-personnel.

Q. 41: . 41: Write short note on the role of Mutual funds in the financial market. (May, 2003)

29
Answer Mutual funds are important segments of the financial market. They channelize the savings and invest in the financial market, mainly in capital market and money market. Ordinary investor has neither skill nor time to recognize the investment opportunity and act immediately. MFs, on their behalf, make use of investment opportunities to earn attractive returns. They provide a good balance of risk and return with different options to suit the various needs of various investors.

Mutual Funds and Household Savings

Savings is encouraged when it finds safe and proper channels for investments. MFs have encouraged savings by providing such channels. In the absence of MFs, the household savings would have been at low levels.

Mutual Funds and Capital Market

MFs constitute one of important segments of capital market. A major part of savings of ordinary households will not come to capital market except through mutual funds. Mutual funds aim to strike a balance between risk and return, and give best of both to its unit holders. They also provide the unit holders with liquidity. The result is that a large portion of household savings come to capital markets through mutual funds. With large funds under their management, MFs strongly support the capital market. Their action, based on intelligent decisions, reduce the volatility of capital markets. Many times, the actions of MFs have helped in controlling the unwarranted crash in the capital market. On other occasions, their actions have controlled unreasonable increase in prices. Corporate debt market, in India, survives mainly due to MFs. They are major investors of debt issues particularly of long term maturities.

Mutual Funds and Money Market

Money market is an important part of financial market. It plays a crucial role in maintaining the equilibrium between the short-term demand and supply of money. It is a market for short-term money. Such schemes invest in safe highly liquid instruments included in commercial papers. certificates of deposits and government securities. Money market MF schemes generally provide high returns and highest safety to the ordinary investors. Money market MF schemes are active players of the money market. They channallize the idle short funds, particularly of corporate world, to those who require such funds. This process helps those who have idle funds to earn some income without taking any risk and with surety that whenever they will need their funds, they will get (generally in maximum three hours of time) the same. Short-term/emergency requirements of various firms are met by such MFs. Participation of such. MFs provide a boost to money market and help in controlling the volatility.

30
Mutual Funds and Corporate Finance
Corporates require huge amount of funds for their workings, MFs provide these funds some times directly by way of participation in public offers and private placements and other times indirectly by being important part of capital and money markets. Q .No. 42: 42: What are the rights and obligations under Mutual Fund Regulations? (Nov. 2005) Answer Rights of a Mutual Fund Investor 1. Receive unit certificates or statements of accounts confirming your title within 30 days from the date of closure of the subscription under open-end schemes or within 6 weeks from the date of request for a unit certificate received by the Mutual Fund; 2. Receive information about the investment policies, investment objectives, financial position and general affairs of the scheme (Every investor has the right to receive a copy of the annual statement); 3. Receive dividend within 30 days1 of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase; 4. Vote in accordance with the Regulations to: a. b. change the Asset Management Company; and wind up the schemes;

5. To receive communication from the Trustee about change in the fundamental attributes of any scheme or any other changes which would modify the scheme and affect the interest of the investors and to have option to exit at prevailing Net Asset Value without any exit load in such cases; 6. Inspect the documents of the Mutual Funds specified in the scheme's offer document; 7. Investors have proportionate right in the beneficial ownership of the scheme's assets as well as any dividend or income declared under the scheme; and 8. To inspect major documents i.e. material contracts, Memorandum of Association and Articles of Association (M.A. & A.A) of the AMC, Offer document etc. Obligations of a Mutual Fund Investor (i) To study the offer document carefully before investing, and (ii) To study the various reports sent by the Mutual Fund from time to time.

SEBI has laid down the limit of 6 weeks. Association of Mutual Funds of India has laid down the limit of 30 days.

31
Q. No. 43 Explain briefly the advantages of investing in mutual funds. . (May, 2007)(June, 2007)(June, 2009) Advantages of investing in a mutual fund : (1) (2) (3) (4) (5) (6) Professionally managed portfolio Diversified portfolio Low cost of investment Liquidity Transparency Simplicity

Q. No.44 Explain the disadvantages of investing in Mutual funds. (June, 2009)

Answer Answer (i)

(ii)

(iii)

(iv)

The investors in the Mutual funds depend on the skill, experience and analysis of professional managers. The returns on their investments depend on the fund manager's skill and judgment. Investors invest their money in the Mutual funds on the basis of the faith they have in some Mutual Fund Manager. If that Manager leaves the Mutual Fund, the investors have to depend on the skill and judgment of some other Manager. Mutual funds incur various expenses fund manager fees/salary and bonus, administration charges, advisory charges, custodian expenses, registration expenses, trustee expenses, accounting and auditing fees, publicity expenses etc. The investors have to share the burden of these expenses. Some times the small investors suffer on account of actions of large investors. Suppose a large investor opts for redemption, the Mutual fund has to redeem its holding immediately this may be the case of forced sale and the redemption proceeds may be less than the market level. This brings down the NAV and the end result is that the small investor suffers. Some times the Mutual funds hold large amount of cash. This reduces the return to the investors.

Q. No. 45 Write a short note on Fund of Funds with reference to the Mutual funds. Answer FOF is a mutual fund that invests in other mutual fund schemes, rather than investing in shares and debt instruments. In today's world, when a fairly large number of mutual fund schemes are available in the finance market, an ordinary investor, who is short of expertise as well time, gets confused and is unable to choose the scheme that suits him. In this situation, he may opt for FOF. Kotak Flexi Fund of Funds is an example of this. The concept has not been popular in India, mainly on account of tax

32
angles2. The tax benefits available for ordinary Mutual Funds are not available for Fund of Funds. The Association of Mutual Funds in India has approached the government to re-look in this matter.

The concept of fund of funds (FoFs) has not really picked up in India in a big way. The biggest reason has been the tax treatment meted out to them. Despite being equity-oriented, fund of funds are treated as debt funds