SECTION I

PORTFOLIO MANAGEMENT

CHAPTER I

INTRODUCTION

The study of portfolio management : The objective of this thesis is to learn ways to

manage one’s money so as to derive maximum benefit from what one earns.

To accomplish one needs to know about the investment alternatives that are available

today. And what is more important is to develop a way of analyzing and thinking about

Investments that will remain with you in the years ahead when new and different

investment opportunities become available. The anlysis involves the examination of past

performance, present conditions and future prospectus.

Many changes have occurred in the securities markets during the last few years in terms

of theory, new financial instruments and trading practices. There have been a lot of

developments in private sector mutual funds. As Investors today are more aware of the

advantages of a good Investment Portfolio, they also find out more and more information

on the Investment options. A lay Investor may not understand the techniques of the

investment market, he may be aware of the potentialities of planning, of tax planning and

right investment decisions to make money. The study of portfolio (investment)

management is necessary for the financial manager as well as the investor.

Section I : Includes Introduction to the concept of portfolio management, its

definition, objectives. Also on the construction of a portfolio and the risk and return

associated with portfolio.

1

Section II : Includes the details on the current Investment options, its benefits and the

risk involved with each option.

Section III : Includes the Investiments for NRI’s and FII’s. There are certain norms

or guidelines by SEBI which have been covered in this section.

Section IV : This concluding section covers the evaluation of performance of a

portfolio and certain Investment tips for good investment.

CHAPTER II

OVERVIEW TO PORTFOLIO MANAGEMENT

For most of our life, you will be earning and spending money. Rarely though, will your

current money income exactly balance with your consumption desires. These imbalances

2

will lead one to either to borrow or to save to maximize the benefits from one’s income.

But one has to only save money under the mattress then after years the money got back is

the same amount of money which is saved. But if one has to invest this savings in a

proper form then in future larger sums of money would be available. The investor who

gives up Rs 100 will expect

atleast Rs 150 in return. Investment is the employment of funds with the aim of getting

return on it. It is the commitment of funds which have been saved from current

consumption with the hope that some benefits will be received in the future.

Investors include individuals with surplus funds, which they desire to invest for short or

long term period with safety and fair returns. Various avenues of Investments are

available. Every avenue has certain advantages and disadvantages. Some investment

avenues provide maximum safety but low returns whereas some provide maximum

returns but low safety.

One of the major advances in the investment field over the past decade has been the

recognition that the creation of an optimum investment portfolio is not simply a matter of

combining a lot of unique individual securities that have desirable risk-return

characteristics. But it has been seen that to build an optimum portfolio one has to keep in

mind as to what is his portfolio objectives.

MEANING OF PORTFOLIO MANAGEMENT

Portfolio means combined holding of many kinds of financial securities i.e. shares,

debentures, government bonds, units and other financial assets. The object of portfolio is

to reduce risk by diversification and maximise gains.

Portfolio management means selection of securities and constant shifting of the portfolio

in the light of varying attractiveness of the constituents of the portfolio.

The Modern Portfolio theory quantifies relationship between risk and return and assumes

that an investor must be compensated for assuming risk.

Basic portfolio theory was originated by Harry Markowitz (Nobel Prizewinner) in the

early 1950’s. While investors before then knew intuitively that it was smart to diversify

3

(i.e. don’t "put all your eggs in one basket.") Markowitz was among the first to attempt to

quantify risk and demonstrate quantitatively why and how portfolio diversification works

to reduce risk for investors. He was also the first to establish the concept of an "efficient

portfolio". An efficient portfolio is one which has the smallest attainable portfolio risk for

a given level of expected return (or the largest expected return for a given level of risk).

The process for establishing an optimal (or efficient) portfolio generally uses historical

measures. Historical measures are used as a proxy for expected future returns which may

or may not be true, particularly over the short term.

MODERN PORTFOLIO THEORY

The 4 basic steps in Modern Portfolio Management are :

a) Security Valuation : That is identifying assets in terms of their expected risk and

expected returns.

b) Asset Allocation Decision : It means deciding how assets are to be allocated to

various classes on investments.

c) Portfolio Optimization : It is achieving the best returns for a particular level of risk

by choosing selected investments avenues.

d) Performance Measurements : It is analysing each assets performance into market-

related and industry or individual share related risk.

OBJECTIVES OF PORTFOLIO MANAGEMENT:

The basic objective of portfolio management is to maximise yield and minimise risk. The

objective of holding any financial asset is to earn ensured return. But any investment has

its associated risk/probability of yielding return.

The other objectives are as follows:

1) STABILITY OF INCOME

4

An investor considers stability of income from his investment. He also considers the

stability of purchasing power of income.

2) CAPITAL GROWTH

Capital appreciation has become an important investment principle. Investors seek

growth stocks, which provides a very large capital appreciation by way of rights,

bonus and appreciation in the market price of a share.

3) LIQUIDITY

An investment is a liquid asst. It can be converted into cash with the help of a stock

exchange. Investment should be liquid as well as marketable. The portfolio should

contain a planned proportion of high grade and readily saleable investment.

4) SAFETY

Safety means protection for investment against loss under reasonably variations. In

order to provide safety a careful review of economic and industry trends is necessary.

In other words errors in portfolio are unavoidable and it requires extensive

diversification. Even investor wants that his basic amount of investment should

remain safe.

5) TAX INCENTIVES:

Investors try to minimize their tax liabilities from the investments. The portfolio

manager has to keep a list of such investment avenues along with the return risk,

profile, tax implications, yield and other returns. An investment programme without

considering tax implications may be costly to the investor.

EFFICIENT PORFOLIO ALSO NEEDS :

Asset Allocation

While this process can be performed on any portfolio with two or more assets, it is most

commonly applied to asset classes. Asset allocation is the process of allocating funds to

each asset class. Each asset class will generally have different levels of return and risk.

5

Correlation Coefficient

Correlation coefficient is a measure of the degree to which two assets (or investments)

move together.

The value of the correlation coefficient ranges from -1 to +1. Assets, which have a

correlation coefficient of -1, their values move simultaneously in opposite directions and

magnitude.

For a value of +1 they are perfectly positively correlated.

Returns

Total return is a measure of the combined income and capital gain (or loss) from an

investment.

Risk (Standard Deviation or Returns)

The Standard Deviation of (historical) returns is probably the most common measure of

the risk of listed securities and portfolios. It is a statistical measure which measures the

variability of returns (about the mean or average). The higher the standard deviation, the

more uncertain the outcome over any period.

Optimal Portfolios

By computer processing the returns, risk (standard deviation of returns) and correlation

coefficients data, it is possible to establish a number of portfolios for varying levels of

return, each having the least amount of risk achievable from the asset classes included.

Assumptions

Modern portfolio theory makes some assumptions about investors. It assumes they dislike

risk and like returns, will act rationally in making decisions and make decisions based on

maximising their return for the level of risk that is acceptable

6

CHAPTER II

PORTFOLIO CONSTRUCTION

Portfolio construction means determining the actual composition of portfolio. Portfolio

construction requires the knowledge of the different aspects of securities. The different

approaches to portfolio construction are :

1. INTERIOR DECORATING APPROACH

7

2. MARKOWITZ APPROACH

INTERIOR DECORATING APPROACH :

Is tailor made to the investment objectives and constraints of each investor. The portfolio

will consist of the securities which will suit the investment objectives. An individual

investor ahs to carefully develop his portfolio over a period of years to suit his needs and

match his investment objectives.

The investor will have to consider the following important categories of investment

opportunities :

Protective investment

Tax oriented investments

Fixed income investments

Emotional investments

Speculative investments

Growth investments

With the help of these varieties of investment we can develop a matrix for matching the

individual characteristics of specific investment so that a suitable portfolio can be

developed for each investor.

MARKOWITZ APPROACH

This approach provides a systematic search for optimal portfolio. It enables the investors

to locate minimum variance portfolio that is portfolios with the least amount of risk for

different levels of expected returns. It is the process of combining assets that are less than

perfectly positively correlated in order to reduce portfolio risk without sacrificing

portfolio returns. The main purpose is to locate a minimum variance portfolio.

8

CHAPTER III

RISK AND RETURN

Portfolio analysis begins where security analysis ends and this fact has been very

important for investors. Portfolio analysis considers the determination of future risks and

return in holding various blends of individual securities.

Portfolio expected return is a weighted average of the expected return of individual

securities but portfolio variance in sharp contrast can be something less that a weighted

average of security variance. As a result an investor can sometimes reduce portfolio risk

by adding another security with greater individual risk than any other security in a

portfolio.

9

A portfolio is a selection of securities since it is rarely desirable to invest the entire fund

of an individual in a single security it is essential that every security be viewed in a

portfolio context. It is logical then that the amounts invested in each security should be

important. Since portfolio is expected return is a weighted average of the expected returns

of its securities the contribution of each securities to the portfolio expected returns

depends on its expected return and its proportionate share of the initial portfolio market

value. It simply follows that investor who wants the greatest possible expected return

should hold one security the one which is considered to have the greatest expected return.

Very few investors do this instead investors should diversify that is include more than

one security in their portfolio.

Risk

Of all possible questions which the investor may ask the most important one is concerned

with the probability of actual yield being less than zero. That is a loss. Instead of

measuring the probability of a number of different possible outcomes the measure of risk

should somehow estimate the extent to which the actual outcome is likely to diverge from

the expected.

In order to estimate the total risk of a portfolio of assets several estimates are needed the

variance of each individual asset under consideration for inclusion in the portfolio and the

covariance or correlation coefficient of each asset with each of the other assets.

Between the two extremes of investment certainty and investment uncertainty lies the

area of investment risk. Under conditions of risk investors realise that there is a range of

possible returns and can associate some probability to each possible return. The

dispersion of possible returns represents risk. The greater the dispersion on an investment

the greater is the risk.

The risk that equity shares can carry are :

Loss of dividend when no dividend is declared.

Low dividend i.e. dividend lower than banks fixed deposits rates

Stagnation in the price of shares

Insolvency of the company.

10

TYPES OF RISK

DEFAULT RISK

It is the risk of issuer of investment going bankrupt. An investor who purchases shares or

debentures will have to place the possibility of default and bankruptcy of the company.

BUSINESS RISK

Is the risk of a particular business failing and thereby the investment is lost. The principal

determinants of a firm’s business risk are the variability of sales and it’s operating

leverage. Business risk can be divided into two categories External and Internal

External business risk is the result of operating conditions imposed upon the firm, which

is beyond its control.

Internal business risk is associated with the efficiency with which a firm conducts its

operations.

FINANCIAL RISK

It is a function of the company’s capital structure of financial leverage. The company

may fall on financial grounds if its capital structure tends to make earnings unstable.

Financial leverage is the percentage change in net earnings for a given result from the use

of debt financing in the capital structure. When the operating profits fall the company

will have to pay large interest payments and the net profit will fall even more. The

likelihood of a company defaulting on its debt servicing obligations is known as financial

risk.

PURCHASING POWER RISK

It is the variation of real returns on the security caused by inflation. Inflation reduces the

purchasing power of money. As price rise the purchasing power of a rupee falls and the

real return on an investment may fall even though the normal return in current rupee

rises. The return on an investment after adjusting for inflation is known as real rate of

return.

RATE RISK

The earnings of companies and their performance of the shares are sensitive to interest

rate changes. The prices of debt securities and all other securities with fixed payout are

dependent on the level of market interest rate. If interest rates rises bond values will fall

11

the return on other types of securities also depends upon interest rates. But when market

interest rates rises the bond rate rises and vice versa.

MARKET RISKS

The market risk means the variability in the rates of return caused by the markets

upswings or downswings. It is caused by investor reaction to tangible as well as

intangible events in market. Some securities are quite sensitive to changes in the market

and has a high degree of market risk while others fluctuate very little while the market

changes.

LIQUIDITY RISK

It arises from the inability to convert an investment quickly into cash. In a security

market liquidity risk is a function of the marketability of the security. When an investor

wants to sell a stock he is concerned with his liquidity whereas when an investor wants to

buy a stock he is interested in its availability.

A stock may be regarded as not easily available and the purchaser has to wait for quite

some time to buy it at a price, which is more or less equal to previous price.

RETURN

The return means the profit earned on the capital invested in the business. Investor

invests their funds to make a profit, which is known as a return.

From an investor’s point of view expected return includes gains in terms of dividend /

interest, bonus, capital appreciation, etc. and such returns are always measured for a

given period of time. This is generally indicated as a percentage return on the initial

amount invested. Again such returns can be realised and not realised (notional) at the

time of gain analysis. Return therefore, can be defined in the following manner:

r = ( p1 - p0 + d1 ) / p0 x 100

Where r = Expected rate of return from the investment

p0 = Market price at time 0

p1 = Market price at time 1

12

d1 = Cash Dividend for period 1

Thus return to an investor during a given period is the sum total of

- cashflows by way of dividend/interest, and

- change in the value of investment, which may be realised or notional.

Flow of return and capital appreciation from an investment can not be forecasted with

cent percent certainty. Some quantity of risk is always associated with it. The actual flow

of return may vary both in positive and negative ways from what is the expectation.

MEASURES OF RETURN

Return can be measured as a rate of return on capital invested. To measure the rate of

return an investor wants to know 3 items

The period of time that the measurement covers

The net profit of the investment over the time period

The amount needed to establish and maintain the investment

The final component of return is usually the purchase price if the security.

RISK - RETURN RELATIONSHIP

Risk and return are probably the two main concerns of investors. The relationship

between the two for and investment is that the investors will want some more return from

investments that have greater risk. Thus investment with higher risk level should have

higher risk level.

Risk and return are an important concept in investment. It takes into account risk

aversion. Government bonds are free from insolvency risk and their returns are also

lowest. Debentures and fixed deposits with companies are not risk free although their

returns are higher. Equity shares carry the highest risk \their returns can also be high from

dividend as well as bonus.

PORTFOLIO RISK

13

Modern portfolio theory believes in the maximization of return through a combination of

securities. It determines the relationship between different securities and then draw inter-

relationship of risk between them.

Although the expected return for a portfolio is an average of the individual securities

return a portfolio risk can be less than the average of it’s the risk of its component

securities. The key to the amount of risk reduction that diversification can achieve is he

degree of correlation of returns on the security and the returns on the existing portfolio.

Modern Portfolio theory states that by combining a security of low risk with another

security of high-risk success can be achieved by an investor.

14

SECTION II

INVESTMENT AVENUES

15

CHAPTER I

INVESTMENT AVENUES IN CURRENT ECONOMY

The current economic scene has brought investors to a great deal of confusion. As you go

to find greater safety, you get lower returns and vice versa. Also, the investment avenues

suddenly seem to have dried down. However, this may not be true. Investors must focus

into finding out Solutions for carrying out their investment rather than making investment

into any product, randomly.

Gold, property, bank deposits, life insurance have been traditionally the investment

avenues in India. The conventional instruments like Gold have waned as their importance

have come down and returns have been negligible. Property prices have crashed and

hence investment into the same is no longer a very rewarding proposition. Investment

opportunities are also available in the form of corporate deposits, mutual funds, equity

and private insurance. However, India has a skewed pattern of investment with only 4%

of the savings being diverted towards the equity market. This has been on account of the

risk being associated with equity investing, but more due to a wrong approach, lack of

awareness, lack of professional counseling.

The various investment avenues and their returns are given in the table below –

Instrument Safety Liquidity Returns (%) Tax aspect

Gold High High 5-20 Taxable

Property High Low Variable Taxable

Bank Deposit High Medium 9-11 Taxable

Insurance High Low 9.50 Tax free

Corporate

Deposits

Low Medium 12-15 Taxable

Mutual Funds

(Debt)

Medium High 8.75-9.25 Tax free

* Returns are based on past data

16

Mutual Funds still hold a promise. In the past year, with the fall in stock markets, Mutual

Funds have become the favorite whipping boys of investors. However this is not entirely

true. Income funds have generated excellent returns over the past one year of around 16-

18%. Balanced schemes also have a decent track record. Though the equity funds have

lost quite a bit over the past one year in line with the stock market trend, a few of the

diversified funds have still managed a positive return since inception.

Onset of Private Insurance. Another good avenue of investment, which has been largely

ignored by Indians, is insurance Currently only 10% of the total disposable income

among Indians goes towards insurance when the ideal allocation should be close to 30%.

Innovative products, which have been launched by the private insurance companies, offer

superior returns over the long term.

Equities offer big scope. The common investor has been disenchanted with equity

investments over the past one year given the persistent losses. There is a sense of

disillusionment for making equity investment. However, it may not be entirely correct.

Given the current scenario equity offers the most exciting investment opportunity over

the long term. Some reasons for the same are explained here. Firstly, India’s market cap

to GDP ratio is towards the lower end when compared with the other equity

markets in the world.

Country Market cap in US $

billion

GDP $ billion Market Cap to GDP

ratio (%)

USA 16635 8351 200

Japan 4546 4078 111

Germany 1432 2079 70

France 1475 1427 103

China 330 980 33

India 184 442 42

South Korea 308 397 77

(fig of April 2001)

17

The market cap to GDP ratio of current times for India would be below 30% as the rates

have plummeted further thereafter. It can be very easily ascertained from this that other

countries in the world have looked at Capital Market very positively for doing growth,

whereas the Indian Investors have not looked at it that way.

Secondly, Nasdaq, Dow Jones and the Sensex are at their trough with the sensex touching

its 8 year lows recently. An interesting thing to observe is the average of sensex over the

last eleven years. Going by such an average of the high/low movements, currently the

sensex is 24% lower than in 1991, 30% lower than in 1995 and 33% lower than in 1998.

Select Companies have outperformed in worst times. The myth that equity investment

means losses can be proved wrong by investing in good, strong companies. Historically it

has been seen that if one invests in fundamentally good companies, one gets good returns

over the long term. Some bluechips have provided returns despite all odds over the last

six-seven years.

If investments are made carefully, equities are also capable of delivering returns over the

medium to short term. For eg. Companies like Cipla, Dr. Reddy’s, HDFC, Gujarat Gas,

Sun Pharma, Blue Dart have appreciated in medium to short term time span of 6 months,

and 1 to 3 years also.

Risk goes down if you have a long-term investment ability. It has also been seen that in

equities risk diminishes as the holding period increases, as per an

Economist Survey of Equity returns worldwide.

Company Current Market

Cap Rs crs

Returns % CAGR

1995-2000

Share of Mkt

Cap

Brittania 1350 22 0.31%

Cipla 7200 22 1.64%

Dr. Reddy’s 7200 41 1.64%

Infosys 15500 31 3.52%

Wipro 22000 49 5.00%

Reliance 24240 11 5.51%

Zee 3198 35 0.73%

18

HLL 43910 25 9.98%

HDFC 7854 32 1.79%

Returns per year

Holding period Minimum Maximum

1 -59 159

5 8 36

10 12 25

15 13 22

20 12 18

CHAPTER II

INVESTMENT AVENUES

COMPANY BONDS

A bond is an investment option that pays its holder, interest for a pre-determined period

of time at a rate and frequency fixed at the time of its issue. The period can be short term

or long term and interest inflow to you can be annual, half-yearly, quarterly or even

monthly. Let us look at the basic aspects of this debt instrument.

BOND FUNDS

A bond fund, like a stock fund, can give an investor access to a diversified portfolio of

securities that would be difficult for most individuals to attain through direct investment.

Through a bond fund, individual investors typically gain access to bonds of

19

denominations that may otherwise be out of their price range as well as 'institutional

vehicles' – investments often unavailable to the general public – at reasonable prices. The

fixed-income markets are generally less risky (smaller price fluctuations) than the stock

markets – but reduced risk historically has meant you will give up something in long-

term returns. Like stocks, total returns in bonds comprise regular income and capital

gains.

Bonds usually stress interest income, while stocks rely more heavily on capital gains.

There is no guarantee, but should the economy and job market slow, for example, interest

rates would probably fall further, which could result in additional capital gains for many

bond and bond fund investors. Past performance is no guarantee of future results.

Individual bonds are designed to repay principal at maturity while bond funds maintain

an average maturity and thus have no fixed maturity. When buying a bond fund, you

should pay more attention to the expense ratio than the yield. A fund, after all, can goose

up its yield by taking big risks with your money. And when buying a closed-end bond

fund, pay attention to the discount. Ideally, you want a taxable closed-end bond fund to

have a discount at least 12 times its expense ratio—only ten qualify. The grades tell you

something about how risky a portfolio is. High-risk, long-maturity funds get good grades

in bull markets and bad grades in bear markets. The reverse is true of low-risk short-

maturity funds.

The Bond Fund invests in a diversified portfolio consisting of government securities,

mortgages, corporate bonds, and short-term funds. This fund's return is largely affected

by changes in interest rates.

Basics of bonds

Bond is a negotiable IOU or a loan.

Investors who buy bonds are lending a specific sum of money (principal amount) to the

issuer of the bond.

Issuer can be a corporation, a government or another financial institution.

20

The issuer borrows the money for a specific time period, also known as the tenor of the

bond.

The issuer typically promises to pay, at periodic intervals of time, interest to the

investors. The rate at which the interest is paid is known as the coupon of the bond.

Bond coupons can be fixed or floating.

Frequently used terms - Bond investing

Face value The principal amount for which the bond is issued.

CouponThe interest rate which the bond is going to pay the

investor.

TenorThe time period for which the bond/debt will remain

outstanding

FrequencyThe periodicity with which the coupon payments will

be made to the holder of the bond.

Yield to

maturity

The return which accrues to the holder of the bond, if

the bond is held to maturity, including any capital

appreciation or loss and regular coupon payments.

Settlement dateThe date by which the seller expects the payment for

the bond.

Maturity date The day on which the bond will mature.

21

Face Value of a Bond

The face value of a bond is the amount that the issuer agrees to repay you, the bondholder, at

the maturity date. The amount is also referred to as par value or maturity value. This is the

amount to which interest on the bond is linked. An interest rate of 15% on a face value of

Rs.100 implies that an annual return of Rs.15 will be paid to you on every bond you hold.

Issue Price of a Bond

Issued price is the price at which a bond is originally issued. Normally, the issue price is the

same as the face value. An exception is the money multiplier bond where the issue price is at

a discount to (i.e. lesser than) the face value.

Payment of Original Investment

Interest is paid on bonds until they are redeemed i.e. returned to the issuer. The redemption

date is also known as the maturity date. It is on this date that you can expect to get your

original investment back.

Bonds are usually redeemed at face value, though a premium may be payable in certain

issues. Any accumulated interest will be paid separately at the time of redemption. Thus,

when a bond is redeemed, you will receive a payment that will comprise the face value and

accumulated interest as applicable.

Difference Between a Bond and a fixed deposit

As in a bond, for a fixed deposit in a company, bank or financial institution, a Fixed Deposit

Receipt is issued to you by the institution, specifying a fixed period, the rate of interest and

the frequency of its payment. However, unlike bonds, fixed deposits are always unsecured.

Bonds have a greater liquidity when accompanied by the facilities of premature redemption

and listing on recognized stock exchanges. Bonds issued by financial institutions and blue-

chip corporate have reasonable liquidity on the exchanges and offer you entry and exit

options. We shall look at liquidity of bonds in more detail later.

A distinct advantage of bonds is the wide spectrum of need-based choices they offer.

22

If you are looking for regular income, there are regular income bonds and so on.

In the next article we shall examine what are the factors you should look at before

Investing in a bond.

TYPES OF BONDS

US treasuries

* Treasury securities are issued by the US treasury and are fully backed by the full faith

of the US government

* Market prices of these securities are NOT guaranteed and fluctuate daily

* Interest paid on these securities is usually exempt from state and local income taxes

* US treasury securities come in three forms namely :

Treasury billsTreasury

notes

Treasury

bonds

(upto 1 yr.

mat)

(upto 10

yr. Mat)

(greater than

10 yr. mat)

Corporate Bonds

* Bonds which are issued by various companies with varying quality and in various

maturities

* Maturities range from 1 year to more than 10 years

* Most corporate bonds are assigned a letter coded rating issued by agencies like

Moody’s Investor Service and S and P

* Corporate bonds with low rating or no rating are called high yield bonds since these bonds compensate

investors for the higher risk with higher returns

Zero Coupon Bonds - A different animal

* These bonds DO NOT PAY ANY interest to the bondholder.

* The bonds are quoted at a price which is HEAVILY discounted to face value. This

ensures that the holder is compensated through capital appreciation in the value of the

bond.

23

* These bonds compensate the holder through a yield to maturity, which is higher than

that of bonds with similar maturities.

Callable Bonds

* Certain bonds have provisions which allow the issuer of the bond to call or redeem the bond

prior to its maturity date.

* Callable bonds are redeemed when interest rates fall to a level which enables the issuer to

save money by issuing new bonds at lower interest rates.

* If there is a call option on a bond, it is clearly mentioned in the bond’s prospectus. for callable

bonds, in addition to the yield to maturity, there is a yield to call calculation which calculates the

yield replacing maturity date with the call date.

* To compensate investors for the risk that bonds may be called back, callable bonds tend to pay

higher coupons as compared with other bonds with similar maturities and credit ratings.

Why bonds ?

Principal protection if invested in high quality paper if held to maturity

Periodic interest/coupon payments to manage short term cash flows

Reduces risk across a diversified portfolio

Attractive yields which compensate for lower fixed deposit rates

Potential for capital appreciation through fluctuation in price of bond

Rating of Bonds

* Ratings are assigned by independent bond rating agencies like Moody’s Investors

Service or Standard and Poor’s Corporation.

* Ratings reflect the credit quality of the bond.

* The credit quality reflects the ability of the issuer to pay periodic interest as well as

repay principal amount borrowed upon maturity.

* Usually, a low credit rating demands a higher yield and a high credit rating demands a

lower yield.

* Emerging market debt is considered speculative and commands a higher yield.

24

Computation of return on Bonds

There are two popular techniques used to compute returns on bonds. The two techniques

are as follows namely :

Current yield - This is nothing but the annual coupon interest divided by the market

price of the bond. However, the weakness in this technique is that it does not include the

possibility of any capital appreciation or loss and does not include reinvestment of

dividend earned through periodic coupon payments

Yield to maturity - This method should be used to compare bonds with similar

maturities. The YTM reflects the interest received as well as any capital appreciation or

loss which the holder incurs by holding the bond.

Factors which affect bond prices/YTM

Interest Rates :

It is imperative to understand the relationship between interest rate movement and bond prices.

The relationship is inverse; a fall in interest rates leads to a rise in bond prices; a rise in interest

rates leads to a fall in bond prices.

Consider a bond with face value of Rs1000 paying a coupon of 6% annually. If interest rates rise

to 7%, we have a bond which pays 6% versus a bond which pays 7% both valued at Rs1000. To

compensate for the lower yield, the bond at 6% will become attractive if the price drops below

current price !!.The reverse happens when interest rates fall..

Maturity

The maturity of the bond also impacts the price of the bond. In general, bonds with longer

maturities are more likely to express volatility than their short term counterparts keeping other

factors constant. This is because bonds with long term maturities are more prone to interest rate

change risks which in turn leads to price volatility. hence, you will find that bonds which are

issued for longer tenors are likely to carry a HIGHER yield than bonds with short tenors.

Accrued interest - How to compute and why ?

On bonds which pay periodic coupons, there is an element of accrued interest which must be

25

accounted for accrued interest represents the interest due to the seller of the bond for the time the

bond was held between the last coupon date and the settlement date for the sale.

For example, if a bond pays 6% semi annually on a face value of Rs100, the bond pays the

holder Rs 3 every six months. Suppose that the coupon dates are Jan 01, 1998 and July 1, 1998.

Now, if Sameer Kaul buys the bond with settlement date as March 15, 1998, he has to pay the

seller interest on the bond from Jan 01, 1998 till March 15, 1998. This is because on July 01,

1998, Sameer Kaul will get the entire interest from Jan 01 1998 to July 01 1998.

Accrued interest is not taken into account when we compute yield to maturities.

DURATION OF THE BOND

The duration of a bond helps to answer the question “ When will I effectively receive my

initial investment in the bond “. Duration helps to measure the interest rate sensitivity of a

bond. The change in the price of a bond, given the change in interest rates, can be

determined with the help of the duration of the bond.

Interest Rates Increase Interest Rates Decrease0.5 % 0.5 %

4 year Duration 4.0 4.0Change in rate X 0.5 X 0.5Percentage changein bond price

- 2.0 % + 0.2 %

---------------------------------------------------------------------------------------------------------------------------------

FIXED DEPOSITS

A fixed deposit (FD) with a bank is a relatively safe investment. There are a few factors

that one must check thoroughly to get the maximum benefits out of a bank FD.

Interest Rate:

Basically, there are three factors you should consider regarding interest rate on fixed

deposits. Currently, banks pay between 6.25% and 10% as interest on FDs, with different

tenures carrying different rates. A tenure that gives you a 10% interest with one bank

26

might only fetch 9% in another. So in the first place, you have to choose a bank that pays

high interest for a term of your choice.

Secondly, remember, the interest on FDs is calculated every quarter. You have a choice

of asking the bank to credit it to your savings or current account every quarter or add it to

the sum you have deposited. If you prefer accumulation rather than periodical

withdrawal, you will get the benefit of compounding.

Thirdly, by keeping a deposit for one more day, you might get a higher return. For

example, if a bank offers 8% for 1 year but 9% for a term between 1 and 2 years, go for a

13 months' deposit that will fetch you 9% (unless you need the money exactly after 12

months). Technically, you can open a fixed deposit for any length of time above 15 days -

even for one year and one day to take advantage of the interest rate structure

Tax Deduction At Source :

Interest income from bank deposits is exempt from tax up to Rs. 9,000 per year under

Section 80 L of Income Tax Act. For example, if your total taxable income is Rs.

1,50,000 out of which the interest income from bank deposits is Rs. 20,000, then your

total taxable income becomes (1,50,000-9,000) or Rs. 1,41,000.

At the same time, banks are obliged to deduct tax at source on deposits that fetch more

than Rs. 5,000 per year. If an individual holding a deposit, the bank has to deduct tax at

source (TDS) at the rate of 10.2% (including surcharge). If the deposit is in a corporate

name, the tax deduction at source (TDS) is calculated at 20.4% (including surcharge).

However, if one informs the bank that they do not have tax liability at all then one needs

to furnish to the bank a form called `15H' . Then the bank will not cut any TDS from the

deposit. All this effectively means that generally, if the interest income from a bank

deposit is above Rs. 5,000 a year but below Rs. 9,000 (the tax exemption limit), then one

can claim the refund for the TDS deducted when filing returns.

27

Remember, the mandatory TDS limit of Rs. 5,000 a year applies not to a bank but to a

bank's branch, more specifically to all the deposits held in a particular branch. So, if your

interest income will exceed Rs. 5,000 from a branch, try and distribute the cluster of

deposits among a few branches of the same bank, if you can help it. This will save you

the hassle of having to collect refunds from the IT department.

Premature Withdrawal Facility

Till about three years ago, banks levied a uniform 2% penalty on premature withdrawal

of deposits. It worked like this. If one has to break a two-year deposit that fetched you a

10% return in say, seven months, one would get the rate applicable for seven months

(say, 7%) less 2% (that makes it 5%). The Reserve Bank of India (RBI) has now left it to

the bank's discretion to levy a penalty. Most banks levy a 1% premature withdrawal

penalty on the applicable rate.

The other option is to take a loan on the deposit (you can take up to 75% of your deposit

as a loan) than by withdrawing before maturity. On the loan too, which will be for the

remaining tenure of the deposit, you will pay interest that is 2% above the rate you are

getting.

SENIOR CITIZENS DEPOSITS SCHEMES

Most banks today, are offering senior citizens interest rates of 0.5-1 percent higher on

fixed deposit schemes than they offer to the others. Some banks like Global Trust,

Karnataka and Saraswat bank have launched special schemes where apart from high rates

on fixed deposits, they also offer some add-ons like, free demand drafts and loans at

concessional rates against fixed deposits.

The recent scam in the US - 64 scheme of UTI has added to the woes of the ordinary

citizen. In addition, there has been an all round slashing in the PPF and NSC rates by 1-

1.5 percent. The special schemes and higher rates on fixed deposits come handy at a time

when the avenues of where to invest money have become very few for the risk wary

investor.

28

Most banks ask for some proof of age for senior citizens and this could range from a

passport copy, a pension payment order, school leaving certificate, voter identity card,

driving license, LIC policy, ration card or age certificate issued by the chief medical

officer of the district.

SOME OF THE SCHEMES OFFERED ARE:

Monthly interest facility on deposits provided the amount of deposit is Rs 10,000 and

above with a minimum period of one year.

Two remittance/drafts per calendar month up to an aggregate amount of Rs 10,000

are permitted free of bank charges to any centre where the bank has a branch to the

senior citizens who maintains an aggregate deposit of Rs 25,000 and above in the

same branch.

It also offers immediate credit of local/outstation cheques up to Rs 7,500 to those

senior citizens whose accounts are satisfactorily operated.

Interest rates up to 0.75 percent per annum extra on senior citizens' deposits. This

higher rate of interest is applicable to term deposit, reinvestment deposit, flexi unit

deposit and recurring deposit products of the bank.

One can choose an investment from a period ranging from 15 days to 10 years.

It also offers the facility of opening a savings account without the minimum balance

stipulation. So you can transfer your interest earnings into this account.

A structured monthly income plan can also be designed to meet your needs.

Door step service for account opening

Free MyTime Card and 2424 phone banking

3 free personal demand drafts per month (only for SB account)

Free collection of outstation cheques drawn on branch locations

Concessional interest rates for demand loans/overdraft against own deposit

In case the senior citizen wishes to avail a loan the bank is offering a 100 percent loan

against your fixed deposit, at an interest rate of one percent over your fixed deposit

rate.

29

Changes In Rates

Over the past few months some banks have slashed interest rates on fixed deposits while

others have kept them constant.

For example, State Bank of India, has cut the rates it is offering on fixed deposits of 1-2

years maturity by 0.5 percent to 9 percent from 9.5 percent and for 2-3 years deposits to

9.5 percent from 10 percent. However, some banks like Centurion Bank continues to

offer a high rate of 11.25 percent on there deposit schemes for over one year deposits.

Some of the other private banks offering good rates to senior citizens are Global Trust

bank and IndusInd bank, both offering 10.75 percent on fixed deposits over one year.

Karnataka Bank is also offering a good rate of 10.5 percent for deposits between 1-3

years and 11 percent for deposits over three years.

The latest rates for senior citizens in the table given below.

FIXED DEPOSIT INTEREST RATES FOR SENIOR CITIZENS

Bank's Name Min Amt(Rs) 6m-1 yr 1-2 yrs 2-3 yrs Over 3 yrs

State Bank of India 10,000 NA 9% 9.50% 9.75%

Centurion Bank 1,000 10.5 11.25% 11.25% 11.25%

Canara Bank 1,000 8% 9% 9.50% 10%

Global Trust Bank 5,000 10.25% 10.5-10.75% 10.75% 10.75%

Punjab National Bank 1,000 7.50% 9% 9.50% 9.75%

IndusInd Bank 10,000 9.25-9.75% 10.75% 10.75% 10.75%

Bank of Baroda NA 7.50% 9.25% 9.75% 9.25%

Allahabad Bank Any Amt 8.50% 9% 9.50% 10.00%

Karnataka Bank NA 9.50% 10.50% 10.50% 11%

ICICI Bank NA 8% 8.50% 8.50% 9%

Saraswat bank 10,000 NA 11% 10% 10%

The TDS Rules

According to the changes in tax liabilities brought about by the 2001-2002 Union Budget,

TDS will apply to all interest earnings above Rs 5,000 on fixed deposits from June 1,

2001, compared with the earlier R s 10,000 limit. This limit of Rs 5,000 is applicable for

every branch of a bank. What this means, is that if your interest earnings on fixed

30

deposits exceeds Rs 5,000 in any branch of any bank, a TDS at the rate of 10 percent will

be deducted from the excess amount. If you take an average interest rate of nine percent

per annum on one year fixed deposits, it is advised not to keep a sum of over Rs 50,000

as fixed deposit in any branch of a bank. This TDS obligation is applicable to senior

citizens as well, until and unless they can supply the bank with the Form 15 H, which

states that their income is below the taxable income slab of Rs 50,000.

PUBLIC PROVIDENT FUND (PPF)

Provident funds are the third largest investors in this market. They have to invest 25% of

their incremental deposits in Govt. dated securities, 15% in State Govt.

. securities, 40% in PSU bonds and they can invest a maximum of 10% of their

incremental deposits in rated private sector debt instruments. Apart from these statutory

instruments, these instruments provide these institutions with fairly good assured returns

coupled with negligible risk.

PPF is one of the attractive tax sheltered investment schemes for middle class and

salaried persons. This scheme was introduced in 1969 and has been improved from time

to time.

A PPF account can be opened at any SBI or any nationalized banks. It can be opened by

an individual or HUF.

The PPF account is for a period of 15 years and it can be extended for 5 more years. The

depositor is expected to make a minimum deposit of RS 100 every year. In addition

money can be deposited once every month. The maximum permissible deposit per year is

RS 60,000. The investment in PPF account must be made out of taxable income and not

out of borrowed funds.

The PPF account is not transferable, but nomination facility is allowed.

31

The deposit in the PPF account are qualified for tax rebate under the income-tax act i.e.

20% of investments made. The balance in a PPF account is fully exempted from the

wealth tax.

A compound interest of 11% p.a. is paid in the case of PPF account. This interest is

accumulated in the PPF account and this income is also exempted from tax payment.

The depositor to a PPF account is eligible for one withdrawal per financial year after five

years from the end of the year in which the subscription is made. It is limited to 50% of

the balance at the end of the fourth year.

On maturity the credit balance in the PPF account can be withdrawn by the depositor.

Due to these special advantages such as attractive interest rates, withdrawal facility an

exemption from income tax. At present the PPF scheme is the most attractive avenue for

investment t in the case of tax payers.

---------------------------------------------------------------------------------------------------------------------------------

UTI SCHEME

The Unit Trust of India is the first investment institution started in the public sector in

India. It is an example of mutual fund wherein savings of individuals are pooled together

for safe and profitable investment with the help of professional experts. UTI as an

investment intermediary was established on February 1st 1964 and has completed more

than 36 years of its operations. Its activities are fast expanding during this period. It has

mobilised more than Rs 15,000 crores through various open ended and close ended

investment schemes. The number of unit holding accounts now exceed 2 crores. UTI is

the single largest investor in the Indian stock market and it provides financial support to

Indian industry. The basic objective of UTI is to encourage savings habit in the society

and to pool the savings of the people for secured and profitable investments. UTI also

aims at providing the benefit of diversified investment and expert management to

32

investors. It plays an important role in bringing industrial development and also in raising

the rate of capital formation in the country.

Advantages Of UTI Scheme1. Benefit of profitable and diversified investment.

2. Limited risk in the investment as UTI operates in the public sector.

3. Benefits of professional management as regards investments.

4. Reasonably high rate of dividend

5. Income tax exemption is available to the income from UTI

6. Wide choice is given to the investor while investing his savings

7. Prompt and satisfactory service to investors who are quite large (more than two

crores)

8. UTI provides reinvestment facilities of dividend income earned by the investors.

9. Units of UTI are easily acceptable by banks for granting loans.

10. The benefit of capital appreciation is available to investors.

Investment in UTI is possible at nay time by purchasing different types of units. There is

no upper limit of investment in UTI. The scheme introduced by UTI includes open ended

scheme which gives the investor complete flexibility with regard to its investment as he

can invest or de-invest any amount at any time. It also gives the investor instant liquidity

of funds. The other scheme is close ended scheme which ahs a fixed corpus and operates

for a fixed duration at the end of which the entire corpus is dis-invested and proceeds

distributed to unit holders in proportion to their holdings. Thus after, the scheme ceases to

exist. Close-ended schemes include pure growth schemes, tax saving schemes and so on.

The UTI occupies a unique position among the mutual funds as it commands ¾ of the

mutual fund industry in India. The popularity of UTI is a clear indication of the changing

prospective of Indian investors who wish to enter the stock market but feel safer using

mutual funds as a vehicle for such entry. Small investors are interested in securing the

benefits of diversified investment by purchasing shares and other corporate securities.

33

They however avoid making direct investment in such securities due to lack of

knowledge skills and experience. Therefore they to enter stock exchange through UTI.

---------------------------------------------------------------------------------------------------------------------------------

PUBLIC DEPOSITS / COMPANY DEPOSITS

In order to meet temporary financial needs companies accept short term deposits from the

investors such deposits are called public deposits / company deposits and are very

popular among the middle class investors. Public deposits / company deposits refer to the

deposits accepted from the investing class for a certain period minimum 1 year and max.

3 years. Companies offer attractive interest rates on such deposits ranging from 10% to

12%. Shareholders of the company are paid half more interest when they offer such

deposits. These interests are payable on monthly, quarterly, six monthly yearly or on

cumulative basis. Some incentives are offered on accepting money. On maturity the

depositor has to return the deposit receipt to the company and the company pays back the

amount deposited. The depositor can renew his deposit for a period of 1 – 3 years, in such

case he has to submit a fresh application to the company. Many companies are now

supplementing their fixed deposit scheme by cumulative time deposit scheme. Under

which the deposited amount along with interest is paid back in lumpsum on maturity.

Companies appoint share brokers to help them collect such deposits and look after the

administrative work in connection with such deposits. At present along with private

sector companies public sector companies and public utilities are accepting such deposits

in order to meet their working capital needs.

Advantages Of Public Deposits / Company Deposits 1. Public deposits / company deposits are available easily and quickly it involves limited

formalities for the company and the interest investor.

34

2. This method of financing is simple and cheaper than obtaining loans from banks,

investors are also interested as they get interest at a higher rate in comparison to rates

offered by banks.

3. Public deposits / company deposits enable the companies to trade on equity and pay

higher dividends on equity shares.

4. The formalities to be completed for depositing money are easy and simple there is no

deduction of tax at source where interest does not exceed a particular limit.

5. The depositors receive an attractive interest on their deposits, the interest is paid

regularly to depositors.

In India various restriction are now imposed on the public deposits / company deposits by

the RBI. Such restrictions are as per the companies amendment rules 1978. The purpose

behind imposing restrictions is to see that bank deposits are not adversely affected. Such

restrictions are also necessary in order to support public borrowing programs of the

Government and for the healthy growth of the Indian capital market. Restrictions are also

necessary for the protection and safety of investors. While selecting a company special

attention should be given to the following 5 factors:

1. Security

2. Marketability

3. Interest rates

4. Liquidity

5. Exemption from tax

------------------------------------------------------------------------------------------------------------

INVESTMENT IN REAL ESTATE / PROPERTIES

Investment in real estate / properties include buildings, commercial premises, industrial

land, plantations, farmhouses, agricultural land near cities and so on.

35

Such properties attract the attention of affluent investors. They purchase such properties

at low prices and do not sell the same unless there is a substantial increase in the market

price. Sometimes the property is not sold for 20 – 30 years but the resale price is

normally attractive and the owner can recover 4 times or more of the price paid. It may be

noted that liquidity in the case of such properties is limited as quick sale is neither

possible nor profitable. Also documentation formalities are lengthy and costly. A

residential home or building represents the most attractive real estate property for large

majority of investors. It is attractive for the following reason:

Ownership – of a residential house provides owned accommodation and a useful

family asset with saleable value.

There is a capital appreciation of residential building particularly in the urban areas.

Loans are available from different agencies like banks, HDFC, for buying,

construction or renovation of a owned residential building.

Interest from such loans is tax deductible within certain limits.

Wealth tax benefit is available in the case of residential building as the value is

reckoned at its historical cost and not at its present market price.

Large majority of middle and low class people prefer to have own residential

accommodation as it gives convenience and also acts as a profitable investment in the

case of need.

DIVIDEND INCOME

Dividend is that portion of earnings that is paid to equity shareholders. Dividend stability

that is whether dividend remains fixed or fluctuates from period to period is a sign

whether the company is doing well or not. When a firm declares a regular dividend

investors accept the declaration as a sign of continued normal operations, at the same

time if there is a reduction in the declared dividend it will be taken as a sign of expected

trouble in the future. The equity shares holders generally prefer to receive steady

dividend that is a certain amount of fixed cash each year as they make advance

commitments of investments.

36

Cash dividendA large majority of dividend is payable by cash normally cash dividend is paid out of the

current years net profit, cash dividend is declared after few months of the closing of

accounts. The dividend paid to each cash shareholder depends on the number of shares

held by him and the amount of dividend declared by the company.

Stock dividend (Bonus shares)

A stock dividend occurs when the board of directors authorise a distribution of bonus

shares to existing stockholders. This has effect of increasing the number of shares of the

firm. The stock dividend allows the firm to declare a dividend without using up cash that

may be needed for operations or expansions. It’s also an indication of higher future

profits. If the regular cash dividend is continued after an extra stock dividend is declared

the shareholders will receive an increase in cash dividend in the future.

------------------------------------------------------------------------------------------------------------

PREFERENCE SHARE VALUATION AND ANALYSIS :

Preference shares are a hybrid security that is not heavily utilised by corporations as a

means of raising capital. It is hybrid because it combines some of the characteristics of

debt and some of equity. Legally a Preference share represents a position of the

ownership of the company and thus is shown in the balance sheet with the equity shares

as making up the capital stock or equity interest. In the investment practice, however

Preference share is basically a weak corporate security as it has the limitation of bonds

with few of the advantages. It does not enjoy strong legal position of a bond when the

corporation is required to pay return to the investor and refund the principal amount at

maturity. As the returns to the holders are discretionary the corporation is under much

less compulsion to pay preference dividends than to pay bond interest because Preference

shares is merely given the right to receive its specific dividend before any dividends are

paid on the equity.

37

Preference shares do have however certain preferences which makes it similar to bonds

since both bonds and Preference shares usually have 1) a limited return and 2) a prior

claim on assets and income of the corporation. In fact some of the disadvantages of the

Preference shares can be offset if following qualifications of a well performed Preference

shares are taken care of :

It must meet all the minimum requirements of a safe bond

It must exceed these minimum requirements by a certain added margin to offset

the discretionary feature in the payment of dividends, i.e. the margin of safety

must be so large that the directors may always be expected to declare the dividend

as a matter of course.

FEATURES OF PERFERENCE SHARES

The features of Preference shares like those of bonds cover a wide range. Each individual

Preference share will vary as to the features it includes. Corporation financial managers

usually emphasize one or the other set of features while issuing them.

Dividends

Preference shares have dividend provision which are either cumulative or non

cumulative. Most shares have the cumulative provisions, which means that any dividend

not paid by the company accumulates. Normally the firm must pay these unpaid

dividends prior to the payment of dividends on the common stock. These unpaid

dividends are know as dividends in arrears or arrearages.

Participating Preference Shares

Most Preference shares are non participating meaning that the preference shareholder

receives only his stated dividend and no more.

Convertible

Convertible Preference share means that the owner has the right to exchange a Preference

share for a share of equity share of the same company. As in the case of bonds sometimes

38

the number of shares of equity are given. There are times when conversion is determined

on the basis of par value.

Preference Share Yield :-

When Preference shares do not have a maturity date the investors use the current yield to

measure the return available from dividends. They merely divide the annual dividend

payment by the current market price to calculate this yield as follows

CURRENT YIELD = ANNUAL DIVIDEND

MARKET PRICE

------------------------------------------------------------------------------------------------------------

EQUITY SHARE VALUATION AND ANALYSIS :

Equity represents an ownership position in a corporation. It is a residual claim in the

sense that creditors and Preference shareholders must be paid as scheduled before equity

shareholders can receive any payment. In bankruptcy equity holders are in principle

entitled only to assets remaining after al prior claimants have been satisfied. Thus, risk is

highest with equity shares and so must be its expected return. When investors buy equity

shares, they receive certificates of ownership as proof of their being part owners of the

company. The certificate states the number of shares purchased and their par value.

Main Advantages Of Equity Shares Are Listed Below:

Potential For Profit

The potential for profit is greater in equity shares than in any other investment security.

Current dividend yield may be low but potential of capital gain is great. The total yield or

yields to maturity may be substantial over a period of time.

Limited Liability

39

In corporate form of organisation, its owners have generally limited liability. Equity share

is usually fully paid. Shareholders may lose their investment but no more. They are not

further liable for any failure on the part of the corporation to meet its obligation.

Hedge Against Inflation

The equity shares is a good hedge against inflation though it does not fully compensate

for the declining purchasing power as it is subject to the money rate risk. But, when

interest rates are high, shares tend to be less attractive and prices tend to be depressed.

Free Transferability

The owner of shares has the right to transfer his interest to someone else. The buyer

should ensure that the issuing corporation transfers the owner on its books so that

dividends voting rights and other privileges will accrue to the new owner

Shares In The Growth

The major advantage of investment in equity shares is its ability to increase in value by

sharing in the growth of company profits over the long run.

Tax Advantages

Equity shares also offer tax advantages to the investor. The larger yield on equity shares

results from an increase in principal or capital gains which are taxed at lower rate than

other incomes in most of the countries.

INVESTMENT IN SHARES - SOME COMMON QUESTIONS ANSWERED

1. What is electronic trading ?

NSE was the first introduce in India fully automated screen based trading,

thereby eliminating the need for physical trading floors. When stock exchanges go in for

screen- based trading the brokers can trade from their offices wherever they are located.

They are connected from their work stations To the central computer located at the

Exchange via. Satellite using VSATs (Very Small Aperture Terminals). Buy and Sell

40

orders from the brokers reach the central computer located at NSE and are matched by

the computer.

2. What type of instruments are traded in stock exchanges?

The following type of instruments are traded in stock exchanges

(a) Equity Shares (b) Preference shares (c) Debentures (d) Bonds and (e) Units of Mutual

funds.

3. What is Stock Market Index? How does one read of the index?

The index is market capitalization weighted index comprising scientifically selected

stocks having the highest liquidity and largest market capitalization. Each stock will

given a weight in the index equivalent to its market capitalization. The capitalization of

such selected stocks as on a specified date is taken as the "Base capitalization" Daily

price change in index securities is captured in the market capitalization figure and

reflected in terms of index of movement. The index value compares the day's market

capitalization vis a vis base capitalization and indicates how prices in general have moved

over a period of time.

4. How many brokers operate on the Stock Exchange?

The brokers of the stock exchanges are SEBI registered trading members. Many of these

registered brokers have authorised and registered sub-brokers. You should execute your

deal through a SEBI registered sub-broker.

5. How do I deal with a registered sub-broker?

You should send your request for purchase or sale of securities. The sub-broker on

executing your order provides you with a purchase/sale note. This purchase/sale note

originates from the contract note which is issued by the main broker to the sub-broker.

The purchase/sale note would help in resolving any disputes with the sub-brokers.

6. Will a small investor who deals through a sub-broker get bounced back and forth

between the broker and the registered sub-broker in case of a problem ?

41

Several measures have been put in the place to tightly couple the broker/sub-broker

relationship. Though your order is placed through the sub-brokers, the main broker has to

take complete responsibility for your transaction. If your problem does not get resolved

satisfactorily by the sub-broker you should approach the main broker and he would be

legally bound to redress your problem.

7. What is contract note?

Contract note is a confirmation of trade(s) done on a particular day for and on behalf of a

client. A contract note is issued in the prescribed format and manner and it establishes a

legally enforceable relationship between the member and client in respect of the trades

stated in that contract note. Contract notes are made in duplicate, and the member and

client both should keep one copy each.

8 What are the points to be checked by an investor to check the validity of a contract note

?

Name and address of trading member, their SEBI registration number, details of trade

such as order no., trade no., trade time, security name, quantity, rate, brokerage,

settlement no., details of other levies, signature of authorised signatory and the arbitration

clause stating that the trade is subject to the jurisdiction of Mumbai must be present on

the face of the contract note.

9. What is a Book Closure / Record date ?

The ownership of shares of companies traded on the stock exchanges is freely

transferable by registration. However, shares are many times held by buyers without

sending them for registration to the company. In order to be sending it for registration to

the company and in order to be entitled to the benefits such as dividend, bonus, rights

etc., announced by the company, a buyer would need to send it for registration. The

company announces cut-off dates from time to time. The list of members on the company

register as on these cut off dates would be the people entitled to the corporate benefits.

10. What is the difference between book-closure and record-date ?

42

The same logic holds good for record date but the two main differences are in case of a

record date, the company does not close its register of security holders. Record date is a

cut-off date (in the above example 3rd Jan'96) for determining the number of registered

members who are eligible for the corporate benefits (Interim dividend (30%). Secondly,

in case of book-closure, shares cannot be sold on an exchange bearing a date on the

transfer deed earlier than the book- closure. This does not hold good for the record date.

------------------------------------------------------------------------------------------------------------

MUTUAL FUND :

A Mutual Fund is a common pool of money into which investors place their contributions

that are to be invested in accordance with a stated objective. The fund belongs to all

investors with each investor's ownership depending on the proportion of his contribution

to the fund, i.e. the more the contribution the higher the ownership and vice versa.

The concept of a mutual fund originated in 1870s with Robert Fleming establishing the

first investment trust in Scotland in 1890. The mutual fund industry in India was started

by the Unit Trust of India (UTI) in 1963 with the introduction of the Unit Scheme' 64

(US'64). This scheme is the largest in the country.

The year 1987 saw the entry of public sector mutual funds into the market. These were mainly public sector

banks and financial institutions, which established their own Mutual Funds. SBI Mutual Fund, Canbank

Mutual Fund, LIC Mutual Fund and Indian Bank Mutual Fund were among the first to be launched.

Why investing through a Mutual Funds

There are a number of good reasons for an investor to invest through the Mutual Fund

vehicle. These are enumerated below:

Lower Risk

Each investor in the Mutual Fund owns a proportionate part of all the Mutual Fund's assets.

Even with a small amount of investment, he becomes a part owner of a large asset value

43

spread over a number of investments. This is explained below with a specific situation.

You have Rs.10,000 to invest. You want to invest in software stocks. With this amount, you

will be able to purchase in only one or at the most two IT shares. A fall in one or both these

shares can wipe you out! However, if you deposit your money with a Mutual Fund

specialising in investing in IT shares, your Rs.10,000 will go into the pool of money

collected from other investors like you and the Mutual Fund will buy IT shares of a larger

number of companies. Your Rs.10,000 will now be spread over more than 2 companies

reducing the chances of you losing your money. The downside is that if the shares were to

go up, the profits to you would be higher if you directly invest in them than if you invest

through a Mutual Fund. But that is a sacrifice worth making for the sake of safety!

Asset Allocation

Mutual Funds offer the investors a valuable tool - Asset Allocation. This is explained by an

example.

An investor investing Rs.1,00,000 in a Mutual Fund scheme, which has collected Rs.100

crores and invested the money in various investment options, will have his Rs.1,00,000

spread over a number of investment options as demonstrated below:

Investment Type Percentage of

Allocation (% of total

portfolio)

Total Portfolio of

the Mutual Fund

Scheme (Rs.in

crores)

Investor's portfolio

allocation (Rs.)

Equity 57% 57 57,000

Hindustan Lever Ltd 15% 15 15,000

Indian Shaving 12% 12 12,000

Procter & Gamble 10% 10 10,000

Cadbury Ltd. 9% 9 9,000

Nestle Ltd. 7% 7 7,000

Kodak Ltd. 4% 4 4,000

Debt: 43% 43 43,000

Government Securities 20% 20 20,000

Company Debentures 10% 10 10,000

44

Institution Bonds 9% 9 9,000

Money market 4% 4 4,000

TOTAL 100% 100 1,00,000

Types of Mutual Funds

Nature of investment

a. Equity schemes

These schemes invest most of their corpuses in equities of companies in various

industries/sectors/businesses. A very small portion of the corpus is invested in

debt securities in order enable the scheme to repay money to outgoing investors.

Since there is no investment focus on a particular type of business or sector, these

are called diversified equity schemes.

b. Debt/Income schemes

These schemes invest most of their corpuses in debt instruments issued by the

Government, corporates, banks, financial institutions and entities engaged in

infrastructure/utilities. Since these schemes don't focus on capital appreciation but

on earning higher incomes, they are also called income schemes.

c. Balanced schemes

Portfolios of these schemes consist of debt instruments, convertible securities,

preference shares and equities. The investment in equity and debt is more or less

in equal proportion. These schemes' objective is to earn income with moderate

capital appreciation.

d. Money Market schemes

These schemes invest in securities with maturities of less than one year. These

securities are mainly Treasury Bills issued by the Government, Certificates of

45

Deposits issued by banks and Commercial Paper issued by companies. These

schemes also invest in the inter-bank call money market.

e. Gilt schemes

These schemes invest in Government securities with medium to long-term

maturities i.e. more than one year. Although these securities have 'zero' risk

(Sovereign rating), fluctuations in interest rates bring about changes in market

prices of these securities resulting in gain or loss to the investor.

f. Sector Specific schemes

These schemes invest in only one industry or sector of the market such as

Information Technology, Pharmaceuticals or Fast Moving Consumer Goods.

Being a very focused investment option, these schemes carry a high level of

sector and company specific risk.

g. Index schemes

These schemes track the performance of a specific stock market index. The

objective is to match the performance of the index by investing in shares that

constitute the index. Not only do these schemes invest in the same shares that

make up the index, they invest in these shares in the same proportion as the

weightage they are given in the index. For instance, if the index tracked

constitutes shares of Hindustan Lever Ltd. (HLL) wherein HLL's shares make up

25% of the index, the scheme will also invest 25% of its corpus in HLL shares.

h. Tax saving schemes

These schemes are essentially diversified equity schemes with an additional

benefit of offering a tax rebate under section 88 to the investor. This section

stipulates that an investor gets a tax rebate of 20% on a maximum investment

amount of Rs.10,000 per Financial Year in a tax saving scheme. However, the

46

investor has to remain invested for a minimum period of three years in order to

not have the tax rebate cancelled.

i. Bond Schemes

These are focused debt schemes investing primarily in corporate debentures and

bonds or in infrastructure or municipal bonds.

Tenure

a. Open-ended schemes

These schemes are available for sale and repurchase at all times. An investor can

buy units from or redeem units to the Mutual Fund itself, at a price based on the

scheme's Net Asset Value (NAV).

b. Close-ended schemes

These schemes offer units for sale and repurchase at their initial public offering

after which they are not available for either sale or repurchase. An investor in this

scheme has to either hold on to his units till the scheme matures for redemption or

can sell his units in the mutual funds segment of the stock market.

c. Interval schemes

Some close-ended schemes offer repurchase facility for short periods of time

where the investor can directly sell his units back to the Mutual Fund. These are

called 'Interval Schemes'. Mutual funds intimate their investors when they plan to

open repurchase facility for a specific period of time. Also, investors can obtain

this information from popular financial publications, which announce dates during

which interval schemes are open for repurchase.

47

Dividends

a. Payout option : Investors have the option of collecting their dividends in cash

i.e. not reinvesting their dividends back into the scheme.

b. Reinvestment option : Investors have the option of having their dividends

declared and then having it reinvested back into the scheme. This method of

reinvestment is a tax saving tool (dividend income attracts no tax).

c. Growth option : Investors can opt for not having dividends declared at all with

the appreciation in value of the portfolio being constantly added on to the NAV.

This is another method of income reinvestment offered by the Mutual Fund.

Transacting Mutual Funds

Close-ended schemes

While talking about the methodology of purchasing Mutual Fund units, Mutual Funds

schemes should be segregated into close-ended and open-ended schemes. Units of close-

ended Mutual Fund schemes can be purchased either when the scheme is first offered to

the public during its Initial Public Offering (IPO) at the face value (i.e. Rs.10 per unit) or

after it is listed on the stock exchange (at the market price). Close-ended Mutual Fund

schemes don't offer sale and repurchase facilities to its investors once the IPO is closed.

The only exit for the investor is the stock market. Similarly, the only way a person can

buy units of a close-ended Mutual Fund scheme whose IPO is closed, is from the stock

exchange. Here, an existing close-ended scheme investor who has purchased his units

during the scheme's IPO and does not want to stay invested till maturity of the scheme,

can sell his units on the stock exchange to a person wanting of buy units of that scheme.

While purchasing units during the IPO, the investor doesn't have to incur any costs for

purchase. However, while purchasing units from the stock exchange, the investor has to

pay his broker a brokerage fee for purchase of his units. Similarly, while selling units on

the stock exchange, the investor has to pay his broker a brokerage fee for sale of his units.

While purchasing units, the investor has to also incur costs of stamp duty to transfer the

units in his name. However, if the investor purchases units in the dematerialized form, no

48

stamp duty is payable. Brokerage rates range between 1%-2% of the transaction value.

For instance, if an investor purchases 1,000 units at a price of Rs.15 per unit, the total

value of the transaction is Rs.15,000. Brokerage at 1% works out to Rs.150 (1% of

Rs.15,000). Stamp duty rates in the state of Maharashtra are 0.5% of the transaction

value. Taking the above example, stamp duty payable by the purchaser will be Rs.75

(0.5% of Rs.15,000).

Open-ended schemes

Units of open-ended Mutual Fund schemes are first available during the scheme's IPO at

face value (i.e. Rs.10 per unit) and then the Mutual Fund offers sale and repurchases

facilities thereafter (at the current NAV). While investing during the scheme's IPO, the

investor does not incur any cost for investment. However, while purchasing units from

the Mutual Fund after the IPO, the investor may be charged an entry load, which is a

percentage of the NAV at the time he buys the units. Entry loads normally range between

0.5% and 1.5%. For instance, if an investor decides to buy 1,000 units of an open-ended

scheme whose NAV is Rs.15 and the entry load is 1%, he is charged Rs.15.15 per unit.

The advantage of having the sale and repurchase facility from the Mutual Fund is that

there is no stamp duty payable on purchase of the units.

Tracking Performance

On making investments in Mutual Fund schemes, it is very important to track the

investment performance. Tracking the performance of the investment helps an investor

decide whether to hold on to his investment or switch to another Mutual Fund scheme.

------------------------------------------------------------------------------------------------------------

GOLD & SILVER INVESTMENT :

Historically gold and silver have been investments with a mystique, beautiful metals with

intrinsic value that will remain stable investments through wars, inflation and troubled

times. Unfortunately, some unscrupulous dealers in precious metals prey on this

fascination.

49

FORMS OF GOLD AND SILVER INVESTMENT

Gold and silver investments take many forms, which can be confusing to the investor.

They include:

Ingot or bullion

Coins, including those minted by Canada, South Africa, Mexico, and the United

States.

Futures contracts

Certificates

Warehouse receipts

Options on coins

Options on gold futures

Options on gold bullion

If you do decide to invest in precious metals, however, it is always a good idea to consult

with a reputable financial adviser and deal through a recognized merchant, broker of

financial institution.

STEPS INVESTORS CAN TAKE TO PROTECT THEMSELVES

To minimize the risks involved with investing in precious metals, investors heed the

following warnings:

Don't buy precious metals advertised at "below spot prices." Spot prices mean

today's prices fixed on major exchanges. Dealers selling gold or silver below spot

are selling below market. This is a danger sign. Experience has shown that these

dealers often do not buy the ordered metals hoping that the market will go down.

Although they tell customers that gold is going up, the only way dealers selling

below spot can make money is if the price drops so that they can later buy the

ordered metal at a price lower than they sold it top the public.

Be cautious of buying precious metals where the dealer pays a percentage of your

investment as some sort of "rebate" for the right to hold your purchase. This is an

indication of a possible fraud. Since the gold or silver bears no interest sitting in a

50

vault (unless the dealer is in another income producing venture) the only way the

dealer can pay a percentage or interest for holding onto your gold or silver is from

the investments of other customers.

If someone has to hold the gold for the Investor, check into their reputation and

integrity. A real red flag is the refusal of a dealer to timely deliver your gold after

your request.

Make sure the dealer segregates funds. Find out if investment funds are kept

separate from operating funds of the company in some sort of trust agreement. If

the salesperson won't confirm that funds are segregated or you can't find out some

other way, steer clear of the dealer. If investment funds are not segregated and the

company goes out of business, your chances of getting any money back are

greatly diminished.

Money should not be send in the mail to a dealer by certified check. A safe

method of payment, used by many legitimate dealers, is delivery of the bullion or

coins to your bank against your bank draft. The bank will not release the money

until the gold or silver is in its hands or in your safe deposit box.

When buying warehouse receipts for gold, silver or other metals be cautious;

remember, the receipts are only as good as the name of the seller. It is the best to

buy from a major bank or bullion dealer that is government regulated. Similarly in

buying gold or silver certificates always should deal through reputable brokerage

firms or banks.

Deferred delivery contracts for gold and silver are not regulated by federal, state

or provincial governments and that many coin and bullion dealers similarly are

not subject to regulatory oversight.

Small investors should be careful when presented with offers to invest in

"strategic" metals such as cobalt and titanium. Recently some unscrupulous

dealers have been misrepresenting the potential risks and earnings connected with

dealing in these metals.

51

CHAPTER III

ALTENATIVE INVESTMENT OPTIONS

Blue Chip Portfolio

Investment Objective : This portfolio seeks a combination of capital appreciation and

dividend income though investments in the common stocks of some of the largest

companies. Generally, blue chip value portfolios are relatively compact, consisting of

between 20 and 30 stocks drawn from diverse industries. Emphasis is placed on long-

term total returns. Thus, portfolio turnover tends to be relatively low.

Investor Profile : This portfolio is suitable for both conservative and moderately

aggressive growth-oriented investors. Because a majority of the companies whose stocks

have been selected for this portfolio pay a portion of their earnings in cash dividends,

total investment return consists of both current income and capital appreciation. The

portfolio is ideally suited for investors with long term investment horizons.

Investment Philosophy : History indicates that average annual common stock returns

far outstrip the rate of increase in consumer prices. Thus, portfolios that are heavily

invested in common stocks best serve the goals of long-term oriented investors. This

portfolio seeks to capture the returns available from investments in large capitalization

companies while tempering investment risk through both diversification and the purchase

of stocks that possess reasonable valuations. A large body of academic research strongly

suggests that diversified stock portfolios containing issues selling at low price-earnings

multiples tend to outperform similar risk portfolios with higher valuation multiples.

Companies with low valuation multiples tend to be those that are currently out of favor

with investors. These "unpopular" companies are generally those that have reported

52

disappointing financial results during the recent past and their stock prices have suffered

as a consequence.

Investment Process : When selecting blue chip stocks, for this portfolio seek to

capitalize on recent stock price weakness due to which there are temporary glitches in

company performance. Investment selection begins with a search for good companies.

These are firms with above-average historical returns on equity, companies that have

demonstrated that they are capable of sustaining above-average long-term growth rates,

and those that are leaders in their respective industries. In addition, a value discipline

requires that shares be purchased during periods when stock prices in general are

declining. Thus, portfolio turnover tends to be relatively low. Stocks are usually sold

when they return to favor with investors and valuation multiples have expanded

dramatically.

Risk and Return : Although portfolio assets are concentrated in blue chip stocks that

tend to be far less volatile than the stocks of smaller, unseasoned companies, the portfolio

is sensitive to changes in the overall stock market. Portfolio return consists of both

capital appreciation and dividend income. Furthermore, like common stock portfolios in

general, the blue chip value portfolio is subject to short-run swings in stock market

prices.

Global Growth Portfolio

Investment Objective : Its primary investment objective by investing in a wide variety of

mutual funds. As with all aggressively managed portfolios, the pursuit of a greater-than-

average annual return is accompanied by greater-than-average portfolio volatility.

Though aggressive in nature, the portfolio's risk is mitigated by diversification across

several investment categories. The portfolio tends to be dominated by aggressive growth,

sector and international equity funds. At times the portfolio may contain a large

allocation to money market funds for defensive purposes.

Investor Profile : The Global Growth Portfolio is suitable for aggressive investors who

are willing to assume above average risks and those that possess a long-term investment

horizon. Since the portfolio stresses capital gains over current income, it is not suitable

for investors who seek a high level of dividend or interest income.

53

Investment Philosophy : In selecting mutual funds for this portfolio, a premium is placed

on those funds that are sold without sales charges (no-load funds) and those that possess

low annual expense ratios. Also, preference is given to those funds that remain fully

invested in their respective investment category at all times. In addition, the portfolio

may contain index funds that seek to replicate the return of a particular category of assets

and funds whose shares are sold to institutional investors only. Generally, both index and

"institution only" funds possess expense ratios that are well below those of retail funds.

Investment Process : The Global Growth Portfolio is created using a top-down approach

to mutual fund selection. First, analysts assess conditions in the global economic and

financial markets. Variables considered include regional business cycles, expected rates

of inflation, interest rate trends, the value of the dollar relative to foreign currencies, and

global financial market trends. These inputs are used to establish the investment

categories to be included in the portfolio. Next, create target investment category

percentage allocations using financial forecasts as inputs. Once these allocations have

been determined, then begins the search for mutual funds in each investment category. In

addition to viewing the fund's financial characteristics and historical returns. Because

portfolio volatility tends to be above average, closely monitor each allocation and maybe

terminate any investment in particular funds if financial market conditions change. This

is especially true of funds that concentrate their investments in a single industry. Thus,

portfolio turnover tends to be relatively high, averaging between 50 percent and 100

percent annually.

Portfolio Strategy : Portfolio assets, at times, may be concentrated in a small number of

mutual funds drawn from a narrow range of asset categories. That is the nature of

aggressive investing. However, seek the benefits of portfolio diversification and will not

abandon investments in specific investment categories because of disappointing short-

term returns. In addition, it is best to follow a contraire investment strategy, purchasing

funds that invest in asset categories that have recently experienced significant declines

and those that are out of favor with individual investors. Finally, when valuations appear

to be excessive in a number of investment categories, one should not hesitate to increase

allocation to relatively safe money market funds. Although this portfolio may exhibit a

54

higher frequency of trading than some of the other portfolios, it is for investors who

possess a long-term investment horizon.

Risk and Return : Over a normal financial market cycle, the volatility of this portfolio

will vary from a low level to an exceptionally high level of volatility. The portfolio’s

return potential tends to reflect its allocation to growth and aggressive growth mutual

funds. Since the portfolio usually contains a relatively large allocation to international

equity funds, the portfolio contains political and foreign exchange risks in addition to the

normal risks of equity fund investing. However, the goal of this portfolio is to produce

long-run returns in excess of those historically provided by large capitalization stocks.

All Weather Portfolio

Investment Objective : All Weather Portfolio seeks a combination of long-term growth

of capital and current income. The portfolio’s primary investment objective is

preservation of capital and growth of capital as a secondary objective. The portfolio seeks

to reduce risk by investing in several mutual funds, each of which invests in securities

drawn from one of seven investment classes including: large capitalization stocks, small

capitalization stocks, foreign stocks, foreign bonds, domestic bonds, gold stocks, and

money market instruments.

Investor Profile : The All Weather Portfolio is designed for investors seeking a low risk

approach to growth and income investing. The portfolio may be more appropriate for the

conservative portion of an investor's portfolio because of its emphasis on a high degree of

diversification and the inclusion of equity, bond and money market funds in its portfolio.

Investors with relatively short time horizons will find the All Weather Portfolio to be

ideal

Investment Philosophy : The All Weather Portfolio is created on the assumption that

diversification reduces risk and that prudent investors should balance the rewards of

investing with the risks they assume. First, investment capital spread across a wide

spectrum of asset categories allows investors to escape the down drafts in investment

wealth that can occur when one category of assets suffers a severe setback. Second,

because the returns across investment classes are less than perfectly correlated with one

another, losses in one investment category may be offset by gains in other categories. The

55

goal is to produce a portfolio with limited volatility, while providing meaningful return

potential.

Investment Process : When selecting mutual funds for this portfolio a premium is placed

on those funds that have no front-end or back-end sales loads, and those that have

relatively low expense ratios. At times the portfolio may contain index funds that seek to

replicate the performance of a specific investment category (i.e., small capitalization

stocks, large capitalization stocks, etc.). In addition, the portfolio may contain funds

whose shares are sold to institutional investors only. The All Weather Portfolio maintains

a commitment to mutual funds representing each of the above- mentioned investment

classes at all times. However, the percentage of portfolio assets allocated to each

investment class can vary from a target that ranges from five to twenty percent of

portfolio assets depending on the investment climate in each respective category, ongoing

financial market trends, and internal and external economic and financial market

forecasts. The All Weather Portfolio is periodically rebalance when changing prices in

the financial markets cause the portfolio's allocations to specific asset categories to stray

from their intended targets. Such periodic rebalancing tends to result in the sale of fund

shares in those categories that have appreciated significantly and the purchase of fund

shares in those categories that have suffered price declines.

Portfolio Strategy : The portfolio’s main strategy will be to maintain investments in all

asset classes (large stocks, small stocks, domestic bonds, international stocks,

international bonds, gold, and cash equivalents). Therefore, the portfolio will contain

between seven and 11 different no-load mutual funds.

Risk and Return : During the course of a normal market cycle, the portfolio will have a

volatility level approximately half that of the stock market. The goal of the portfolio is to

provide annual returns near market returns, while assuming less risk, although there is no

assurance that these returns can be achieved. The return potential of the portfolio tends to

reflect its allocation to equity, bond and money market funds. Given its allocation

constraints, the portfolio generally contains no more than neither 80 percent of assets

allocated to equity funds nor less than 40 percent with the balance allocated to a

combination of bond and money market funds. The returns of individual portfolios can

56

differ due to such factors as portfolio composition, the timing of client cash flows in and

out of the portfolio and the date on which the portfolio was initially constructed.

Small Cap Value Portfolio

Investment Objective : This portfolio seeks to provide a vehicle that gives investors the

opportunity to capture the "small firm effect." This "effect" is the tendency of the

common stocks of small companies to outperform the common stocks of large companies

at equivalent levels of investment risk. The primary objective is to provide a high level of

long-term capital growth. Although some small growth companies pay cash dividends,

current income is not a consideration in asset selection.

Investor Profile : The portfolio is suitable for both aggressive and moderately aggressive

growth-oriented investors. Best results are obtained when investing for longer-term

capital appreciation. The portfolio provides diversification benefits when combined with

growth portfolios that stress large-cap stocks and international equities.

Investment Philosophy : Our goal is to provide high capital appreciation potential while

maintaining a portfolio with moderate risk characteristics. Risk is reduced by maintaining

a portfolio diversified across the stocks of 40 to 50 small companies (equity market

values between $30 million and $300 million), and by paying below-average multiples of

sales, earnings and book values when selecting small company growth stocks. Because

transaction costs can erode portfolio returns, we resist the urge to trade frequently. Once

selected, small company stocks are held an average of about three years (i.e., a portfolio

turnover ratio of about 30 percent). examine the historical growth of revenues and

earnings and retain those companies that have demonstrated an ability to grow at a

double-digit annual rate. eliminate companies with excessive levels of long-term debt,

those that have not been profitable for several years, and start-up companies. Finally,

eliminate companies that are selling at excessive multiples of revenues, earnings and

book values. there is a big difference between a "good" company and a "good"

investment. A good investment is the stock of a "good" company that has been acquired

at a reasonable price. No matter how attractive a company's growth prospects, we will not

make an investment in that company if we are required to pay a multiple of projected

earnings that is greater than our estimate of a company's annualized growth rate. The

57

resulting list of stocks is then subjected to rigorous analysis, which may include company

visits, discussions with large shareholders, and discussions with operating management.

Eventual stock selections are those that have above-average growth potential and

reasonable valuations.

Portfolio Strategy : that one of the keys to investment success is proper portfolio

management. Because small company stocks are relatively illiquid, active trading can

erode investment returns by a significant amount. Diversification is another key to

successful small-cap investing. A small-cap portfolio must be more widely diversified

than a blue chip portfolio to reduce company specific or non-specific risk. Diversification

among non-correlated industry groups and the inclusion of 50 to 60 individual issues

reduces volatility while maintaining above-average growth potential. Stocks are sold for

the following reasons: 1) growth boosts a small stock to the point that it joins the ranks of

mid-caps, 2) appreciation in share price causes a stock’s sales, earnings and book value

multiples to become expensive, 3) a Company’s financial condition deteriorates to the

point at which its growth potential becomes impaired, 4) Finally, a sale is "forced" when

a company is acquired by another firm.

Risk and Return : On average, small company stocks have returned more than those of

large companies. Furthermore, small firm stock portfolios can outperform large company

stock portfolios in streaks that can last for several years. Small company growth stock

investing can provide for more volatility than other investment strategies. Small firm

stocks are thinly traded and are thus less liquid than the stocks of large companies. Small

companies may not possess adequate access to sources of capital needed to support above

average growth rates. Finally, small companies possess limited product lines, which may

cause their quarterly revenues and earnings to fluctuate more than those of highly

diversified companies. seek growth stocks with low price-earnings ratios relative to their

growth potential, stocks with reasonable multiples of sales and book values, and

companies with strong balance sheets and exceptional track records. In addition, our

small company portfolios are diversified across numerous companies drawn from

unrelated industries, which reduces return volatility.

58

Income Plus Portfolio

Investment Objective : The Income Plus Portfolio seeks a combination of current income

and capital appreciation by investing in bond, money market and equity mutual funds.

The goal of the portfolio is to provide an average annual return in excess of the yield on

long-term government bonds plus the annual rate of increase in the consumer price index.

In short, the objectives of the fund are to produce both current income and to preserve the

purchasing power of portfolio assets.

Investor Profile : This very conservative portfolio is suitable for highly risk averse

investors who require current investment income to meet their living requirements.

Although the equity fund portion of the portfolio seeks to provide capital appreciation,

allocation of assets across equity funds, bond funds, and money market funds provides a

much lower average return than that required by more aggressive investors who seek

primarily capital appreciation.

Investment Philosophy : Highly risk-averse investors, especially those that are retired

and are not adding additional assets to their investment portfolios, frequently invest the

bulk of their assets in low risk bonds or bond mutual funds. Their goal is to meet the twin

objectives of current income and low risk. However, during periods marked by expanding

consumer prices, this strategy may possess more risk than meets the eye. That's because

rising consumer prices erodes the purchasing power of both future interest income and

the capital invested in bonds or bond funds. Even a modest increase in consumer prices,

when experienced over several years, can exert a significant impact on the purchasing

power of a so-called fixed income portfolio. On the other hand, investors could preserve

the purchasing power of their assets by investing in a portfolio that increases in value by

at least two percent annually. By allocating a modest portion of portfolio assets to

conservatively managed growth and income mutual funds that are capable of producing

double digit average returns over the long run, the purchasing power of portfolio assets

can be maintained and even increased.

Investment Process : Portfolio assets are allocated among money market funds, bond

funds, and growth and income funds. The specific allocations are determined by market

conditions. For example, during a financial environment marked by a flat yield curve

(i.e., short-term bond yields are similar to those of long-term bonds) the allocation to

59

money market funds would be increased while the percentage of assets invested in long-

term maturity bond funds would be decreased. During periods of low inflation and robust

economic expansion, a larger portion of assets would be allocated to conservatively

managed equity funds. When selecting bond funds, we seek those that invest in high

quality corporate bonds and government bonds, and those with relatively low annual

operating expenses. During periods marked by a declining value of the dollar relative to

major foreign currencies, international bond funds may find their way into this portfolio.

And during periods marked by rapid expansion of consumer prices, a small allocation to

a well-managed gold fund might be used as an inflation hedge. The equity fund portion of

the portfolio may contain balanced funds, convertible bond funds, equity-income funds,

or sector funds (such as utility funds) that invest in high yielding equities. Individual fund

selections are based on unfolding trends in the economy and the responsiveness of fund

share prices to those trends.

Portfolio Strategy : Although the portfolio is kept in tune with unfolding events in the

economy and financial markets, portfolio turnover is kept relatively low. Rapid turnover

of fund shares, especially those of equity funds, can result in the premature payment of

capital gains taxes. For taxable accounts, funds that have declined in price during the

calendar year will be sold and the proceeds reinvested in funds with similar objectives

and management style. The goal is to offset realized capital gains with realized capital

losses to minimize taxes. Mutual fund income and capital gains distributions, unless

otherwise specified by the client, will be reinvested in additional fund shares.

Risk and Return : Although the Income Plus Portfolio is conservatively managed,

investors face the usual risks of bond and equity investing. Rising interest rates cause

bond prices to fall. Thus, the prices of bond fund shares can decline in an inflationary

environment marked by rising interest rates. In addition, an economic recession causes

corporate earnings to decline, which can negatively impact the shares of equity funds.

However, because portfolio assets are allocated across equity, bond and money market

funds, portfolio volatility is significantly lower than that experienced by the stock market.

Thus, the portfolio is ideally suited for highly risk averse investors. The goal of this

portfolio is to produce an average annual rate of return equal to the sum of the yield on

30-year government bonds and the annual rate of change in the Consumer Price Index.

60

For example, if 30-year treasury bonds yield six percent while the annual rate of inflation

is two percent, the goal would be to produce an average annual return in excess of eight

percent. However, there is no guarantee that this portfolio will meet its stated investment

objective.

Pure-growth Open-ended Debt-based schemes (PODs)

Of MFs have evolved as the best parking place for all investible funds of all the investors,

rich or otherwise, taxpayers or otherwise. Since the fund is required to invest only in

government securities or investible-grade rated securities, the capital is safe, very safe.

The returns therefrom are also safe. Many experts have been stating that in the era of

falling interest regime, the returns from this avenue would also fall. Theoretically, this is

a universal truth but in practice, the returns rise when the interest falls. Very strange but

true. We shall examine the reason giving rise to this phenomenon.

To illustrate, we assume that the current NAV of the mutual fund is Rs. 10 and its corpus

is Rs. 1000 crores. This means that if the fund sells all the assets of the scheme and

distributes the money on equitable basis to all the unit holders, they will receive Rs. 10

per unit. Now suppose, the interest rate falls from 10 percent to 9 percent. Immediately

thereafter you wish to invest Rs. 1 lakh in the scheme. Realise that the entire corpus of

the fund stands invested at an average return of 10 percent. If the fund sells the units to

you at it’s current NAV of Rs. 10, you will be allotted 10,000 units. This will benefit you

immensely. You will be a partner in sharing the benefit of the higher returns of 10

percent, though the fund will be forced to invest your Rs. 1 lakh at the lower rate of 9

percent.

This is injustice to the existing investors.

Here comes the ‘mark to market’ concept. The fund raises its NAV to Rs. 11.11. You will

be allotted only 9,000 units and not 10,000. The returns on 9,000 units @10 percent

would be identical with the returns on 10,000 units @9 percent. Actually every

investment @ 10 percent of face-value Rs. 10 is revalued at the new rate of interest of 9

percent , which works out to Rs.11.11. This is treated as the value of the asset and the

NAV of the fund rises. In other words, the NAV rises when the interest falls. This is an

automatic process. The fund manager does not have to take any buy-sell action to hike up

61

the NAV. SEBI has laid down some strict guidelines for computation of NAVs by

factoring in the market rate of interest. It is therefore very clear that the investor in debt-

based schemes of mutual funds is protected even against the falling rate of interest. The

proof of the pudding is in eating it.

Normally, the performance of a fund manager is gauged by the rate of returns achieved

by him. The debt-based scheme is a different animal. The performance is overshadowed

by the mark-to-market. The playing field is almost identical for all the fund managers.

The market rate is determined by the health of the economy, government policies and

many other factors which are strictly beyond the control of the fund manager, though he

can have an educated guess at its rise or fall across the time dimension.

Though the past performance is no guarantee for future achievements, normally, an

investor enters into a scheme on the basis of the current performance of the fund. Higher

the rate greater is the attraction. However, in the case of debt-based schemes, a little

caution is required to be exercised while choosing the exact parking place.

Understandably, the mark-to-market does not provide a protection for ever. After some

short time, the returns from the scheme will eventually come down to meet the market

rate. How short is this short? Well, the various instruments held in the current corpus will

continue to give the high contracted rate until their respective maturities. When the

investment of face value Rs. 10, revalued @11.11 matures the fund receives Rs. 10 only

and the asset value reduces by Rs. 11.11 and NAV of the fund falls. Therefore, the

average period to maturity of the corpus becomes a more important selection-oriented

criterion. Have a look at the last column of the Table.

I simply fail to understand why any investor goes to any bank for any investment. How

can one explain the fact that on a year-to-year basis, the bank deposits have risen by 20

percent to Rs. 10,24,828 crores? The entire corpus of all the mutual funds taken together,

debt-based or otherwise, is less than one-tenth of this amount. Or look at the queues for

monthly income schemes of Post Offices. Well, the investor should wake up from his

complacency and embrace PODs passionately. Earlier the better.

Whatever scale you chooses to measure these with, whatever standard you select to

compare these by, PODs have emerged as torchbearer amongst all the investible avenues.

62

NAME OF THE

SCHEME ALLOTMENTDATE N.A.V. EQUIVALENTRATE

OFRETURN percent90 DAYSRATE OFRETURN

180 DAYSRATE OFRETURN %

360 DAYSRATE OFRETURN %

Average Maturity in Years(as on Aug 31 2001)

ALLIANCE INCOME

03/03/1997 17.41 13.03 20.24 17.49 16.73 4.93

BIRLA INCOME +B

23/10/1995 21.09 13.51 19.02 16.88 16.66 3.99

CHOLA TRIPLE A 31/03/1997 17.61 13.57 19.63 18.41 16.58 4.19

DHAN BOND 26/05/1999 13.80 15.05 19.63 18.11 16.88 4.60

DSP ML LYNCH BOND

29/04/1997 17.24 13.26 19.63 16.88 17.80 5.15

HDFC INCOME 11/09/2000 11.72 17.19 19.63 16.88 0.00 4.98

IL&FS BOND 12/07/1999 12.98 12.77 21.16 16.24 16.26 3.10

JF- INDIA BOND 26/11/1997 15.87 12.96 17.19 14.75 15.36 2.72

JM- INCOME 01/02/1995 19.70 10.80 21.46 17.19 18.11 5.50

KOTAK BOND DEPOSIT

05/11/1999 12.66 13.60 18.41 16.27 17.65 4.99

PIONEER ITI INCOME BUILDER

24/06/1997 17.43 14.10 21.46 19.33 18.56 4.71

PRUDENTIAL ICICI INCOME

09/07/1998 14.92 13.45 18.41 16.58 16.88 3.92

RELIANCE INCOME

31/12/1997 15.62 12.84 18.41 16.12 15.66 4.14

SBI MAGNUM LIQUIBOND

01/12/1998 14.08 13.11 17.80 15.05 15.97 4.07

SUNDARAM BOND SAVER

18/12/1997 16.22 13.83 19.63 16.58 17.49 4.27

TATA INCOME 27/03/1997 17.33 13.11 12.92 15.05 13.68 4.15

TEMPLETON INDIA INCOME

02/03/1997 18.01 13.87 17.80 15.97 16.88 4.58

UTI BOND 18/07/1998 14.82 13.30 17.19 14.44 15.21 3.24

ZURICH HIGH INTEREST

11/04/1997 17.35 13.28 21.46 17.19 17.57 4.80

NAVS AS AROUND 10.09.2001

63

Equity Linked Saving Schemes (ELSS)

are Section 88-eligible tax saving mutual fund schemes. Section 88 of the Income Tax

Act, 1961, specifies investment avenues which lead to a 20 per cent tax rebate on the

amount invested. The total limit of investment specified for financial year 2000-01 is Rs

80,000, of which Rs 20,000 is exclusively ear-marked for securities notified as

infrastructure bonds. Among the various other avenues which qualify for the balance Rs

60,000, are investments of up to Rs 10,000 in ELSS. Of the various Section 88

investment options, ELSS is the only truly aggressive wealth-builder. All others, like LIC

premia, PF contributions and

PPF are wealth-protecting, income-generating investments which don't offer

much scope for capital growth. In contrast, the money you put into ELSS is

invested in equity shares, and is capable of handsome appreciation over a

period of time. Of course, they are prone to higher volatility and thus higher

risk. Considering, however, that Rs 70,000 out of the eligible Rs 80,000

under Section 88 is geared towards lower-return, lower-risk investment

avenues, putting Rs 10,000 annually into ELSS makes sense even if you are a

conservative investor; it will help push up the overall returns from your total Section 88

investments.

Key features

An equity-linked saving scheme is a variant of equity mutual funds. The essential

differences from mainstream diversified equity funds are essentially three.

Twenty per cent tax benefit on investment

No such tax benefits are available on other equity funds. In effect, this translates into an

instant, first-day 20 per cent return on your investment in an ELSS, vis-a-vis investment

in another equity fund scheme. How? When you invest Rs 10,000 in an ELSS, your tax is

lowered by Rs 2,000; thus, in effect the IT Department gives you an instant 20 per cent

return.

Higher allocation to equity

64

SEBI stipulates that ELSS must, at all times, maintain an allocation of at least 80 per cent

of their corpus in equities. This high level of exposure to the stock market makes ELSS

an aggressive equity fund with the potential of higher returns compared with other equity

funds, and also more risky as their NAVs are likely to fluctuate more wildly than those of

the mainstream equity funds. For the financial year 99-00, the four ongoing open-end tax

saving funds beat the Sensex by huge margins.

Conversely, under adverse conditions during the calendar year 2000, they lost far more

ground than did the Sensex.

Three-year lock-in period.

Eligibility for a 20 per cent income tax rebate is conditional upon staying invested for a

minimum of three years. For this reason, ELSS investments come with a 3-year lock-in

period. This is a boon both for the investor and the fund managers.

During market downturns, the NAVs of ELSS are likely to fall more steeply than those of

most other equity funds. Falling stock market indices and NAVs are almost sure-fire

triggers that send individual investors into redemption mode often with high but

avoidable losses since holding on for the longer term typically leads to a reversal of

fortunes.

The 3-year lock-in clause prevents such precipitate sales. It also prevents cashing in on

quick gains if markets soar within the 3-year period. True, but since the lock-in specifies

only a minimum holding period, it doesn't stop you from holding on for longer than that

and waiting for a later market rise to redeem.

Similarly, the lock-in also permits the fund managers to play for the long-haul gains.

They don't have to be looking over their shoulders all the time, particularly in the panic-

redemption downturns, guessing the extent of redemption’s they need to cater to by

keeping cash or near-cash holdings.

In a way, the lock-in serves as a risk-management tool for the otherwise more aggressive

equity fund that an ELSS is.

65

Action alert

To make use of the Section 88 tax rebate for financial year 00-01, you must invest before

31 March 2001. So it's time to pick up your ELSS.

It would make greater sense to spread the Rs 10,000 you invest in an ELSS over, say, 10

months at Rs 1,000 each rather than in one lump-sum to catch the 31 March deadline.

This is where the low minimum investment of only Rs 500 comes in handy; many funds

also offer built-in systematic investment options. A staggered investment will ensure that

you don't end up buying into an ELSS at an unusually high NAV level, but rather at an

average NAV spread over several months. This is a great advantage now available ever

since tax-saving ELSSs went open-ended a few years ago.

CHAPTER

66

PORTFOLIO DIVERSIFICATION

If you invest in a single security, your return will depend solely on that security; if that

security flops, your entire return will be severely affected. Clearly, held by itself, the

single security is highly risky. If you add nine other unrelated securities to that single

security portfolio, the possible outcome changes—if that security flops, your entire return

won't be as badly hurt. By diversifying your investments, you have substantially reduced

the risk of the single security. However, that security's return will be the same whether

held in isolation or in a portfolio.

Diversification substantially reduces your risk with little impact on potential returns. The

key involves investing in categories or securities that are dissimilar: Their returns are

affected by different factors and they face different kinds of risks.

Diversification should occur at all levels of investing. Diversification among the major

asset categories—stocks, fixed-income and money market investments—can help reduce

market risk, inflation risk and liquidity risk, since these categories are affected by

different market and economic factors.

Diversification within the major asset categories—for instance, among the various kinds

of stocks (international or domestic, for instance) or fixed-income products—can help

further reduce market and inflation risk.

TIME DIVERSIFICATION

Time diversification, remaining invested over different market cycles, is extremely

important yet often overlooked. Time diversification helps reduce the risk that you may

enter or leave a particular investment or category at a bad time in the economic cycle. It

has much more of an impact on investments that have a high degree of volatility, such as

stocks, where prices can fluctuate over the short term. Longer time periods smooth those

fluctuations. Conversely, if you cannot remain invested in a volatile investment over

67

relatively long time periods, those investments should be avoided. Time diversification is

less important for relatively stable investments, such as certificates of deposit, money

market funds and short-term bonds.

Time diversification also comes into play when investing or withdrawing large sums of

money. In general, it is better to do so gradually over time, rather than all at once, to

reduce risk.

TIMING THE MARKET

The goal of a market timer is to enter the market when it is rising, and exit when it is

falling. While the strategy sounds appealing, it is difficult to execute, since no one has

been able to devise a system that can tell in advance if the market will rise or fall. Market

timers therefore tend to follow the trends, bailing out after the market has started to fall,

and jumping in after it has started to rise. However, the stock market movements are

jerky, not smooth, and allow little time for even the most prescient market timer to act.

Thus, one of the major risks of this kind of strategy is that it may have an investor out of

the market when the bulls stampede.

One recent study examined the distributions of monthly stock returns for the S&P 500

and small stocks from 1926 through 1987. The researchers discovered that the best

returns on the S&P 500 were concentrated in only a few months. Small stock returns

were shown to have been even more concentrated than the S&P returns.

Probably the biggest risk of a market timing strategy is that a few missed bull markets

can negate the long-term return advantage stocks have historically provided. And market

timing strategies sometimes miss the boat. In recognition of this all too familiar trait,

investors should refrain from full-bore timing strategies that require the portfolio to be

either 100% in stocks or 100% in short-term debt. Diversifying a portfolio across asset

types provides protection that is too certain to be discarded for the uncertain promises of

68

market timing. Timing strategies that call for either an all stock or an all debt portfolio, or

almost all stock or almost all debt, contain excessive and unnecessary levels of risk.

If you are interested in market timing strategies, you should at least limit the portion of

your total portfolio that is subject to the risks of market timing.

69

SECTION III

CHAPTER I

GUIDELINES FOR PORTFOLIO INVESTMENT BY FIIS

Government of India in its latest liberalisation move has allowed reputed foreign

investors, such as Pension Funds etc. to invest in Indian capital market. To

operationalise this policy, the Government has evolved guidelines for such investments

by Foreign Institutional Investors (FIIs).

The following guidelines have been formulated in this regard

Foreign Institutional Investors (FIIs) including institutions such as Pension Funds,

Mutual Funds, Investment Trust, Asset Management Companies, Nominee Companies

and Incorporated/Institutional Portfolio Manager or their power of attorney holders

(providing discretionary and non-discretionary portfolio management services) would

be welcome to make investments under these guidelines.

FIIs would be welcome to invest in all the securities traded on the Primary and

Secondary markets, including the equity and other securities/instruments of companies

which are listed/to be listed on the Stock Exchanges in India including the OTC

Exchange of India. These would include shares, debentures, warrants, and the schemes

floated by domestic Mutual Funds. Government may even like to add further categories

of securities later from time to time.

FIIs would be required to obtain an initial registration with Securities and Exchange

Board of India (SEBI), the nodal regulatory agency for securities markets, before any

investment is made by them in the Securities of companies listed on the Stock

Exchanges in India, in accordance with these guidelines. Nominee companies affiliates

and subsidiary companies of a FII will be treated as separate FIIs for registration, and

may seek separate registration with SEBI.

70

Since there are foreign exchange controls also in force, for various permissions under

exchange control, along with their application for initial registration, FIIs shall also file

with SEBI another application addressed to RBI for seeking various permissions under

FERA, in a format that would be specified by RBI's FERA permission together by

SEBI, under a single window approach.

For granting registration to the FII, SEBI shall take into account the track record of the

FII, its professional competence, financial soundness,experience and such other criteria

that may be considered by SEBI to be relevant. Besides, FIIs seeking initial registration

with SEBI shall be required to hold a registration from the Securities Commission, or

the regulatory organisation for the stock in the country of domicile/incorporation of the

FII.

SEBI's initial registration would be valid for five years. RBI's general permission

under FERA to the FII will also hold good for five years. Both will be renewable for

similar five year periods later on.

RBI's general permission under FERA would enable the registered FII to buy, sell and

realize capital gains on investments made through initial corpus remitted to India,

subscribe/renounce rights offerings of shares, invest on all recognized stock exchanges

through a designated bank branch, and to appoint a domestic Custodian for custody of

investments held.

This General Permission from RBI shall also enable the FII to:

Open foreign currency denominated account(s) in a designated bank. (These

can even be more than one account in the same bank branch each designated in

different foreign currencies, if it is so required by FII for its operational

purposes);

Open a special non-resident rupee account to which could be credited all

receipts from the capital inflow, sale proceeds of shares, dividends and

interests;

Open a special non-resident rupee account to which could be credited all

receipts from the capital inflow, sale proceeds of shares, dividends and

interests;

Transfer sums in the securities in India out of the balances in the rupee account;

71

Make investments in the securities in India out of the balances in the rupee

account;

Transfer repatriable (after tax) proceeds from the rupee account to the foreign

currency account(s);

Repatriate the capital, capital gains, dividends,incomes received by way of

interest,etc. any compensation received towards sale/ renouncement of rights

offerings of shares subject to the designated branch of a bank/the custodian

being authorized to deduct withholding tax on capital gains and arranging to pay

such tax and remitting the net proceeds at market rates of exchange;

Register FII's holdings without any further clearance under FERA.

There would be no restriction on the volume of investment - minimum or maximum - for

the purpose of entry of FIIs, in the primary/secondary market. Also, there would be no

lock-in period prescribed for the purposes of such investments made by FIIs. It is

expected that the differential in the rates of taxation of the long term capital gains and

short term capital gains would automatically induce the FIIs to retain their investments as

long term investments. Portfolio investments in primary or secondary markets will be

subject to a ceiling of 24% of issued share capital for the total holdings of all registered

FIIs, in any one company. The ceiling would apply to all holdings taking into account

the conversions out of the fully and partly convertible debenture issued by the

company. The holding of a single FII in any company would also be subject to a ceiling

of 5% of total issued capital. For this purpose, the holdings of an FII group will be

counted as holdings of a single FII.

The maximum holding of 24% for all non-resident portfolio investments, including those

of the registered FIIs,will also include NRI corporate and non-corporate investments, but

will not include the following :

Foreign investments under financial collaborations(direct foreign investments), which

are permitted upto 51% in all priority areas.

a) Investments by FIIs through the following alternative routes:

Offshore single/regional Funds;

72

Global Depository Receipts;

Euroconvertibles.

Disinvestment will be allowed only through stock exchanges in India, including the

OTC Exchange. In exceptional cases, SEBI may permit sales other than through stock

exchanges, provided the sale price is not significantly different from the stock market

quotations, where available.

All secondary market operations would be only through the recognized intermediaries

on the Indian Stock Exchange, including OTC Exchange of India. A registered FII

would be expected not to engage in any short selling in securities and to take delivery

of purchased and give delivery of sold securities. A registered FII can appoint as

Custodian an agency approved by SEBI to act as a custodian of Securities and for

confirmation of transactions in Securities, settlement of purchase and sale, and for

information reporting.Such custodian shall establish separate accounts for detailing on

a daily basis the investment capital utilization and securities held by each FII for

which it is acting as custodian. The custodian will report to the RBI and SEBI semi-

annually as part of its disclosure and reporting guidelines.

The RBI shall make available to the designated bank branches a list of companies where

no investment will be allowed on the basis of the upper prescribed ceiling of 24%

having been reached under the portfolio investment scheme.

RBI may at any time request by an order a registered FII to submit information

regarding the records of utilization of the inward remittances of investment capital and

the statement of securities transactions. RBI and/or SEBI may also at any time conduct a

direct inspection of the records and accounting books of registered FII.

FIIs investing under this scheme will benefit from a concessional tax regime of a flat

rate tax of 20% on dividend and interest income and a tax rate of 10% on long term (one

year or more) capital gains.

73

CHAPTER II

PORTFOLIO INVESTMENT SCHEME FOR NRI’S

To attract foreign investments in the market, the government has drafted a 'Portfolio

Investment Scheme' with alluring features.

Long ago, each and every NRI required the RBI’s special permissions for each and every

company in which he desired to invest! Moreover, the permission was required to be

renewed every 3 years. This was ridiculous. Then the RBI began granting general

permission to those companies which approached it for NRI investments, on the

condition that the company obtains the approval of its shareholders in a general body

meeting. This bypassed the botheration of the NRI of approaching the RBI every time he

desired to purchase shares of a company for which he had not obtained permission. At

present the situation has been further simplified. ADs are allowed to deal in shares on

behalf of their portfolio clients with respect to the general permission. Where special

permission is required, ADs can renew the permission without referring to the RBI after

every 5 years instead of 3 years.

An NRI can authorise an Indian resident, a relative or close friend, or even a stock broker

to act as his agent in India to deal in shares, debentures, units of UTI/MFs, securities

(other than bearer securities) of the central and state government and treasury bills

through stock exchanges. The transactions may be either on a repatriation or a non-

repatriation basis. There is one more restriction that is an NRI should authorise only one

branch of only one bank in India for the portfolio management. Specific PA may be

granted in favour of the bank, to carry out the formalities in respect of:

Applying to the RBI for necessary approval.

Buying and selling shares and debentures.

Subscribing to a new issue of shares and debentures.

Collecting dividend and interest. Holding shares/debentures in safe custody.

Renunciation of right entitlement and

Arrange for repatriation if the investment is on repatriation basis.

74

To protect domestic companies from a corporate raid by the acquisition of a major share

holding, certain ceilings are imposed on the percentage of holding of equities and

convertible debentures. RBI monitors this on an on-line basis.

The restrictions are:

Investment made by any single investor in equity, preference shares and convertible

debentures of any listed Indian company should not exceed 5% of its total paid-up

equity and preference capital, or 5% of the total paid-up value of each series of

convertible debentures issued by it.

The individual ceiling of 5% is only applicable to the first holder of the securities.

The second or the third holders can invest up to 5% individually in their own right as

the first holder. To prevent a raid by a consortium of NRIs, the prescribed overall

ceiling for all NRIs put together is 10% of the share capital, with or without

repatriation rights. However, the company concerned can pass a special resolution in

its general body meeting to enhance the Aforesaid 10% limit to 30%. The special

resolution has to be forwarded to the RBI. FA00 has further raised this limit to 40%.

This is the one and only concession given by FA00 to NRIs. There is a status quo on

all the other provisions. This is the best that could have happened. Mr. Sinha appears

to have focused his attention for extracting his pound of flesh from all who have

prospered, in spite of the government, thanks to their own knowledge, information,

technology and skills.

Purchase of shares and debentures under the scheme is required to be made at the

ruling market price. It is necessary to take delivery of the securities purchased and

give delivery of those sold under the scheme. In other words, speculation in terms of

margin trading or short selling is not allowed.

If on conversion of CDs into shares, the NRI happens to cross the limits, he is

allowed to continue to hold on to his investments. RBI permission, is required even in

respect of shares held before 1.1.74 by NRI individuals, firms, companies, etc., prior

to the commencement of FERA [Sec. 29(4a)].

75

CHAPTER III

SEBI - PORTFOLIO MANAGEMENT NORMS

The Securities and Exchange Board of India's working group formed to review the

regulations for portfolio management schemes has finalised a set of revised regulations

for portfolio managers. Regulations for portfolio managers were first promulgated in

1993.

The new norms for PMS, which were finalised in a meeting of the working group, will

liberalise investment by portfolio managers into areas like derivatives and bill

discounting. In addition the regulations also allow for temporary parking of surpluses in

the automated lending and borrowing scheme and borrowing and lending of securities

scheme (BLESS) operated by the NSE and the BSE, respectively.

In order to ensure that retail investors are not solicited for investments by portfolio

managers SEBI has decided to specify a minimum investment amount of Rs 5 lakh per

client.

SEBI has also permitted more than one company in the same group to obtain registration

as a portfolio manager subject to fulfilling all the conditions laid down under the

regulations.

A minimum set of risk factors and disclosure requirements in a client contract like a

mutual funds offer document and removal on restrictions on investments by PMS

managers in corporate debt instruments too have been laid down.

The new norms also allow for a mutually agreed variable fee structure for PMS clients as

opposed to the current fixed fee structure prevalent. Thus a PMS entity can charge a

variable performance linked or a fixed fee and even a combination of a fixed cum

variable fee, provided the client agrees to it up-front.

76

This was one of the major demands of portfolio managers who felt that like hedge funds

they should be allowed to charge a performance linked fee. MFs too are not allowed to

charge any performance linked fee and have a fee cap specified by SEBI based on type of

the scheme whether equity or debt and assets under management under the scheme.

A performance-based fee structure allows portfolio managers to link their profits with the

maximization of the client's income and is seen as a transparent fee mechanism. SEBI has

also decided to remove the restrictions which prevent PMS investors from withdrawing

their investments within the span of a one year period.

Currently, PMS investors can withdraw the funds entrusted to PMS managers before a

one year period only at the fund manager’s discretion which SEBI feels is not in the

investor interest.

SECTION IV

CONCLUSION

77

CHAPTER I

EVALUATION OF PORTFOLIO PERFORMANCE

Investors must decide how often the portfolio must be revised. If it occurs too often the

analysis cost will be high. And if it is done to infrequently then the benefit of timing

maybe foregone. Ideally investors should buy when prices are low and sell when prices

rise higher than their normal fluctuations.

The first major board of portfolio is to derive rates of returns that equal or exceed the

returns on a selected portfolio with equal risk. The second goal is to attain complete

diversification. Several techniques have been derived to evaluate equity portfolio in terms

of both risk and return.

The Treynor measure considers the excess returns earned per unit of systematic risk. The

Sharpe measure indicates the excess returns per unit of total risk.

Additional work in equity portfolio evaluation has been concerned with models that

indicate what components of the management process contributed to the results.

Friends and Blume contended that there was an inverse relationship between the risk of

the portfolio and its composite performance.

Certain application of evaluation techniques

Degree of risk assumed

That is the portfolio properly diversified, does the investor use margins, if so is it too

much.

78

Selection of individual securities

Does the investor have ability to select undervalued issues.

Cyclical and market timing

Does the investor try to adjust the portfolio and to aggressive neutral or defensive

position. On what basis does he formulate his anticipation of market swings. What

improvements can be made

Risk adjusted returns

The investor must compute annual rates of return on the portfolio the level of risk

assumed in terms of the portfolio. The investor should compare the risk adjusted returns

with those experienced by the market index.

In conclusion investors need to evaluate their own performance and the performance of

hired managers. Though their various techniques and alternative measures all the

measures should be used because they provide different insights regarding the

performance of managers.

CHAPTER II

INVESTMENT PLANNERS / TIPS

TEN COMMANDMENTS

79

A MUST BEFORE YOU INVEST IN ANY STOCK

Ten commandments

1. Sector allocation : You shall allocate sector weightages that are different from

sensex lest you should not achieve the objective of beating the sensex. Also the

objective of limiting risk requires you not to go gung-ho on some sectors as their

fortunes change without taking your permission.

2. Liquid and focussed portfolio : You shall limit your portfolio to 10 and only 10

stocks. All successful investors agree that an unwieldy portfolio is a sure recipe

for below average returns. As all Homo sapiens can err, you shall invest in stocks

where exit is easy i.e. stocks with a minimum market capitalization (we set the

limit at Rs100mn) and have good liquidity (average BSE turnover should exceed

Rs10mn per day in the last 3 months).

3. Avoid tips : You shall not envy your friends getting rich if his/ her stocks appear to

be rising faster than yours. You should not forget that they can fall even faster.

You shall not fall in the trap of getting excited by every tip even if it looks sexy

by its performance in the last few days. None of your investment decisions should

violate any of the 10 commandments.

4. Leaders only : You shall only buy companies that are leading in their respective

industries i.e. they should be in top 5 in the respective Indian industry. An

exception can be made only if there is a big turnaround or restructuring story.

5. Management quality : You shall not buy companies run by managements that

have a track record of incessant equity dilution, taking up unrelated projects,

misleading investors by miscommunications or no proven track record. The only

exception you can make if you have a reliable report that the management is

changing.

80

6. Positive cash flow : You shall invest only in companies that are expected to have a

positive cash flow in the next 3 to 5 years. In other words, the companies that will

have operating cash flows higher than their requirement of cash for capital

expenditure and investments only merit investments.

7. Valuation: You shall not be carried away by P/E multiples. That does not mean

you shall ignore P/Es but requires you to evaluate future P/Es keeping in mind

P/Es of the peer companies and relative growth prospects. Also the investment

candidates should expected to have a favorable change in their EVAs (economic

value added). That is EVA in the next 2-3 years is expected to be substantially

better than the same in the recent past.

8. Industry position: You shall evaluate companies as regards to their competitive

position on the Porter Model which considers parameters like bargaining power

of buyers and suppliers, threat of substitution, competition and changes in

industry structure. You shall find most companies with regulated earnings as out

of your investment arena.

9. Global competitiveness: You shall not invest in companies that are susceptible to

unviablility with competition from imports and global competition. You shall

presume that import duty structure will be aligned to global norms in making this

evaluation. A corollary is that you shall prefer companies with cost advantage, high

operating efficiency and superior quality products.

10. Shareholder friendly: You shall not invest in companies that have track record of

treating minority or non promoter shareholders like step children. Such companies

include the ones that hive off profitable division for a poor consideration or divert

funds to other unknown group companies etc. Other things being equal, prefer

companies that are shareholder friendly in terms of dividend, bonus, transparency,

disclosures in annual reports etc.

81

Conclusion :

In this thesis I have tried to touch apon all the current Investment options which are most

sought after today. Finally the decision as to which is the best option lies with the

Investor. It is very important for a person to find and balanced investment avenues

depending on the returns desired and the risks associated with them. The real risk lies in

not thinking about what you want to do with your money. Hence before investing it is

82

necessary that one must look at his own risk – return criteria and contingencies and

structure the investments to suit these needs.

It would be very clear to you if you ask yourself a question, how soon you wish to double

your money. If the answer is 5 years then, you need to invest in instrument that possibly

can offer 14-15 per cent return. If it is 3 years, then 24 to 25 per cent and so on. If you

look at doubling money in less than five years, Equity could be the one to suit you. If you

can resist with doubling money in more than five years, yet there are many fixed income

instruments, which would provide you with some opportunity. So, structure your needs

and take a call, rather than taking random chances.

BIBILOGRAPHY:

1. Investment Analysis And Portfolio Management Frank K. Reilly – Keith C Brown

2. Modern Investment Theory -- Robert A Haugen

3. Investment Management – Frank J Fabozzi

83

4. Investors Guide To Indian

5. Introduction To Investment – Haim Levy

6. Portfolio Management Handbook – Robert A Strong

7. Internet Sites : Indiatimes Indiainfoline Hometrade The Economic Times

84