Mutual Funds for Beginners !!

Different investment avenues are available to investors. Mutual funds also offer good investment opportunities to
the investors. Like all investments, they also carry certain risks. The investors should compare the risks and
expected yields after adjustment of tax on various instruments while taking investment decisions. The investors
may seek advice from experts and consultants including agents and distributors of mutual funds schemes while
making investment decisions.

With an objective to make the investors aware of functioning of mutual funds, an attempt has been made to
provide information in question-answer format which may help the investors in taking investment decisions.
1. What is a Mutual Fund?
Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in
securities in accordance with objectives as disclosed in offer document.
Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is
reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same
proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money
invested by them. Investors of mutual funds are known as unit holders.
The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally
come out with a number of schemes with different investment objectives which are launched from time to time. A
mutual fund is required to be registered with Securities and Exchange Board of India (SEBI) which regulates
securities markets before it can collect funds from the public.
2. What is the history of Mutual Funds in India and role of SEBI in mutual funds
industry?
Unit Trust of India was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed
public sector banks and institutions to set up mutual funds.
In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to
protect the interest of investors in securities and to promote the development of and to regulate the securities
market.
As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the
interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds
sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised
in 1996 and have been amended thereafter from time to time. SEBI has also issued guidelines to the mutual
funds from time to time to protect the interests of investors.
All mutual funds whether promoted by public sector or private sector entities including those promoted by foreign
entities are governed by the same set of Regulations. There is no distinction in regulatory requirements for these
mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes
launched by the mutual funds sponsored by these entities are of similar type.

3. How is a mutual fund set up?

A mutual fund is set up in the form of a trust, which has Sponsor, Trustees, Asset Management Company (AMC)
and Custodian. The trust is established by a sponsor or more than one sponsor who is like promoter of a
company. The trustees of the mutual fund hold its property for the benefit of the unit holders. Asset Management
Company (AMC) approved by SEBI manages the funds by making investments in various types of securities.
Custodian, who is registered with SEBI, holds the securities of various schemes of the fund in its custody. The
trustees are vested with the general power of superintendence and direction over AMC. They monitor the
performance and compliance of SEBI Regulations by the mutual fund.
SEBI Regulations require that at least two thirds of the directors of trustee company or board of trustees must be
independent i.e. they should not be associated with the sponsors. Also, 50% of the directors of AMC must be
independent. All mutual funds are required to be registered with SEBI before they launch any scheme.

4. What is Net Asset Value (NAV) of a scheme?

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).
Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset
Value is the market value of the securities held by the scheme. Since market value of securities changes every
day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a
scheme divided by the total number of units of the scheme on any particular date. For example, if the market
value of securities of a mutual fund scheme is Rs. 200 lakhs and the mutual fund has issued 10 lakhs units of Rs.
 10 each to the investors, then the NAV per unit of the fund is Rs. 20. NAV is required to be disclosed by the
mutual funds on a regular basis - daily or weekly - depending on the type of scheme.

5. What are the different types of mutual fund schemes?

a) Schemes according to Maturity Period:
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its
maturity period.

 Open-ended Fund/ Scheme

An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis.
These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset
Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.

 Close-ended Fund/ Scheme

A close-ended fund or scheme has a stipulated maturity period e.g. 5 -7 years. The fund is open for subscription
only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time
of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges
where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an
option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI
Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase
facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly
basis.
b) Schemes according to Investment Objective:
A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its
investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such
schemes may be classified mainly as follows:

 Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally
invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide
different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an
option depending on their preferences. The investors must indicate the option in the application form. The mutual
funds also allow the investors to change the options at a later date. Growth schemes are good for investors
having a long-term outlook seeking appreciation over a period of time.

 Income / Debt Oriented Scheme

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in
fixed income securities such as bonds, corporate debentures, Government securities and money market
instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of
fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds.
The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates
fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may
not bother about these fluctuations.

 Balanced Fund
The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities
and fixed income securities in the proportion indicated in their offer documents. These are appropriate for
investors looking for moderate growth. They generally invest 40 -60% in equity and debt instruments. These funds
are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are
likely to be less volatile compared to pure equity funds.

 Money Market or Liquid Fund

These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate
income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of
deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes
fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors
as a means to park their surplus funds for short periods.

 Gilt Fund
 These funds invest exclusively in government securities. Government securities have no default risk. NAVs
of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with
income or debt oriented schemes.

 Index Funds
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, NSE 50 index (Nifty),
etc. These schemes invest in the securities in the same weightage comprising of an index. NAVs of such
schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same
percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard
are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds which are traded on the stock
exchanges.

6. What are sector specific funds/schemes?

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the
offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc.
The returns in these funds are dependent on the performance of the respective sectors/industries. While these
funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch
on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice
of an expert.

7. What are Tax Saving Schemes?

These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the
Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes
(ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth
oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any
equity-oriented scheme.

8. What is a Fund of Funds (FoF) scheme?

A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as
a FoF scheme. An FoF scheme enables the investors to achieve greater diversification through one scheme. It
spreads risks across a greater universe.

9. What is a Load or no-load Fund?

A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells un its
in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution
expenses. Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors
who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will
get only Rs.9.90 per unit. The investors should take the loads into consideration while making investment as
these affect their yields/returns. However, the investors should also consider the performance track record and
service standards of the mutual fund which are more important. Efficient funds may give higher returns in spite of
loads.
A no-load fund is one that does not charge for entry or exit. It means the investors c an enter the fund/scheme at
NAV and no additional charges are payable on purchase or sale of units.

10. Can a mutual fund impose fresh load or increase the load beyond the level

mentioned in the offer documents?

Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any change in the load
will be applicable only to prospective investments and not to the original investments. In case of imposition of
fresh loads or increase in existing loads, the mutual funds are required to amend their offer documents so that
the new investors are aware of loads at the time of investments.
11. What is a sale or repurchase/redemption price?
The price or NAV a unit holder is charged while investing in an open-ended scheme is called sales price. It may
include sales load, if applicable.
Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its
units from the unit holders. It may include exit load, if applicable.

12. What is an assured return scheme?

Assured return schemes are those schemes that assure a specific return to the unit holders irrespective of
performance of the scheme.
A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is
required to be disclosed in the offer .
Investors should carefully read the offer document whether return is assured for the entire period of the scheme
or only for a certain period. Some schemes assure returns one year at a time and they review and change it a t
the beginning of the next year.

13. Can a mutual fund change the asset allocation while deploying funds of

investors?
Considering the market trends, any prudent fund managers can change the asset allocation i.e. he can invest
higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer
document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the
fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the
investors. In case the mutual fund wants to change the asset allocation on a permanent basis, they are required
to inform the unit holders and giving them option to exit the scheme at prevailing NAV without any load.

14. How to invest in a scheme of a mutual fund?

Mutual funds normally come out with an advertisement in newspapers publishing the date of launch of the new
schemes. Investors can also contact the agents and distributors of mutual funds who are spread all over the
country for necessary information and application forms. Forms can be deposited with mutual funds through the
agents and distributors who provide such services. Now a day, the post offices and banks also distribute the units
of mutual funds. However, the investors may please note that the mutual funds schemes being marketed by
banks and post offices should not be taken as their own schemes and no assurance of returns is given by them.
The only role of banks and post offices is to help in distribution of mutual funds schemes to the investors.
Investors should not be carried away by commission/gifts given by agents/distributors for investing in a particular
scheme. On the other hand they must consider the track record of the mutual fund and should take objective
decisions.

15. Can non-resident Indians (NRIs) invest in mutual funds?

Yes, non-resident Indians can also invest in mutual funds. Necessary details in this respect are given in the offer
documents of the schemes.

16. How much should one invest in debt or equity oriented schemes?
An investor should take into account his risk taking capacity, age factor, financial position, etc. As already
mentioned, the schemes invest in different type of securities as disclosed in the offer documents and offer
different returns and risks. Investors may also consult financial experts before taking decisions. Agents and
distributors may also help in this regard.

17. How to fill up the application form of a mutual fund scheme?

An investor must mention clearly his name, address, number of units applied for and such other information as
required in the application form. He must give his bank account number so as to avoid any fraudulent
encashment of any cheque/draft issued by the mutual fund at a later date for the purpose of dividend or
repurchase. Any changes in the address, bank account number, etc. at a later date should be informed to the
mutual fund immediately.

18. What should an investor look into an offer document?

An abridged offer document, which contains very useful information, is required to be given to the prospective
investor by the mutual fund. The application form for subscription to a scheme is an integral part of the offer
document. SEBI has prescribed minimum disclosures in the offer document. An investor, before investing in a
scheme, should carefully read the offer document. Due care must be given to portions relating to main features of
the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit
loads, sponsor‘s track record, educational qualification and work experience of key personnel including fund
managers, performance of other schemes launched by the mutual fund in the past, pending litigations and
penalties imposed, etc.

19. When will the investor get certificate or statement of account after investing in

a mutual fund?
Mutual funds are required to dispatch certificates or statements of accounts within six weeks from the date of
closure of the initial subscription of the scheme. In case of close-ended schemes, the investors would get either
a demat account statement or unit certificates as these are traded in the stock exchanges. In case of open-ended
schemes, a statement of account is issued by the mutual fund within 30 days from the date of closure of initial
public offer of the scheme. The procedure of repurchase is mentioned in the offer document.

20. How long will it take for transfer of units after purchase from stock markets in

case of close-ended schemes?

According to SEBI Regulations, transfer of units is required to be done within thirty days from the date of
lodgment of certificates with the mutual fund.

21. As a unit holder, how much time will it take to receive dividends/repurchase

proceeds?
A mutual fund is required to dispatch to the unit holders the dividend warrants within 30 days of the declaration of
the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or
repurchase request made by the unit holder.
In case of failures to dispatch the redemption/repurchase proceeds within the stipulated time period, Asset
Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).

22. Can a mutual fund change the nature of the scheme from the one specified in

the offer document?

Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes of the
scheme e.g. structure, investment pattern, etc. can be carried out unless a written communication is sent to
each unit holder and an advertisement is given in one English daily having nationwide circulation and in a
newspaper published in the language of the region where the head office of the mutual fund is situated. The unit
holders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to
continue with the scheme. The mutual funds are also required to follow similar procedure while converting the
scheme form close-ended to open-ended scheme and in case of change in sponsor.
23. How will an investor come to know about the changes, if any, which may

occur in the mutual fund?

There may be changes from time to time in a mutual fund. The mutual funds are required to inform any material
changes to their unit holders. Apart from it, many mutual funds send quarterly newsletters to their investors.
At present, offer documents are required to be revised and updated at least once in two years. In the meantime,
new investors are informed about the material changes by way of addendum to the offer document till the time
offer document is revised and reprinted.

24. How to know the performance of a mutual fund scheme?

The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of
open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are
required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All
mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India
(AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place
The mutual funds are also required to publish their performance in the form of half-yearly results which also
include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception
of schemes. Investors can also look into other details like percentage of expenses of total assets as these have
an affect on the yield and other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to the unit holders at the end
of the year.
Various studies on mutual fund schemes including yields of different schemes are being published by the
financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports
on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors
should study these reports and keep themselves informed about the performance of various schemes of different
mutual funds.
Investors can compare the performance of their schemes with those of other mutual funds under the same
category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE
Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual
fund scheme.

25. How to know where the mutual fund scheme has invested

money mobilized from the investors?

The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly basis which are
published in the newspapers. Some mutual funds send the portfolios to their unit holders.
The scheme portfolio shows investment made in each security i.e. equity, debentures, money market
instruments, government securities, etc. and their quantity, market value and % to NAV. These portfolio
statements also required to disclose illiquid securities in the portfolio, investment made in rated and unrated debt
securities, non-performing assets (NPAs), etc.
Some of the mutual funds send newsletters to the unit holders on quarterly basis which also contain portfolios of
the schemes.

26. Is there any difference between investing in a mutual fund and in an initial

public offering (IPO) of a company?

Yes, there is a difference. IPOs of companies may open at lower or higher price than the issue price depending
on market sentiment and perception of investors. However, in the case of mutual funds, the par value of the units
may not rise or fall immediately after allotment. A mutual fund scheme takes some time to make investment in
securities. NAV of the scheme depends on the value of securities in which the funds have been deployed.
27. If schemes in the same category of different mutual funds are available,

should one choose a scheme with lower NAV?

Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one
available at higher NAV. Sometimes, they prefer a new scheme which is issuing units at Rs. 10 whereas the
existing schemes in the same category are available at much higher NAVs. Investors may please note that in
case of mutual funds schemes, lower or higher NAVs of similar type schemes of different mutual funds have no
relevance. On the other hand, investors should choose a scheme based on its merit considering performance
track record of the mutual fund, service standards, professional management, etc. This is explained in an
example given below.
Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both schemes are diversified
equity oriented schemes. Investor has put Rs. 9,000 in each of the two schemes. He would get 600 units
(9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10 per cent
and both the schemes perform equally good and it is reflected in their NAVs. NAV of scheme A would go up
to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900 (600*
16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B (100*99). The investor would get
the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes
and allotment of higher or lower number of units within the amount an investor is willing to invest, should not be
the factors for making investment decision. Likewise, if a new equity oriented scheme is being offered at Rs.10
and an existing scheme is available for Rs. 90, should not be a factor for decision making by the investor. Similar
is the case with income or debt-oriented schemes.
On the other hand, it is likely that the better managed scheme with higher NAV may give higher returns
compared to a scheme which is available at lower NAV but is not managed efficiently. Similar is the case of fall
in NAVs. Efficiently managed scheme at higher NAV may not fall as much as inefficiently managed scheme with
lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme
instead of lower NAV of any scheme. He may get much higher number of units at lower NAV, but the scheme
may not give higher returns if it is not managed efficiently.

28. How to choose a scheme for investment from a number of schemes available?
As already mentioned, the investors must read the offer document of the mutual fund scheme very carefully.
They may also look into the past track record of performance of the scheme or other schemes of the same
mutual fund. They may also compare the performance with other schemes having similar investment objectives.
Though past performance of a scheme is not an indicator of its future performance and good performance in the
past may or may not be sustained in the future, this is one of the important factors for making investment
decision. In case of debt oriented schemes, apart from looking into past returns, the investors should also see the
quality of debt instruments which is reflected in their rating. A scheme with lower rate of return but having
investments in better rated instruments may be safer. Similarly, in equities schemes also, investors may look for
quality of portfolio. They may also seek advice of experts.

29. Are the companies having names like mutual benefit the same as mutual

funds schemes?
Investors should not assume some companies having the name "mutual benefit" as mutual funds. These
companies do not come under the purview of SEBI. On the other hand, mutual funds can mobilize funds from the
investors by launching schemes only after getting registered with SEBI as mutual funds.

30. Is the higher net worth of the sponsor a guarantee for better returns?
In the offer document of any mutual fund scheme, financial performance including the net worth of the sponsor
for a period of three years is required to be given. The only purpose is that the investors should know the track
record of the company which has sponsored the mutual fund. However, higher net worth of the sponsor does not
mean that the scheme would give better returns or the sponsor would compensate in case the NAV falls.

31. Where can an investor look out for information on mutual funds?
Almost all the mutual funds have their own web sites. Investors can also access the NAVs, half-yearly results and
portfolios of all mutual funds at the web site of Association of mutual funds in India (AMFI) www.amfiindia.com.
AMFI has also published useful literature for the investors.
Investors can log on to the web site of SEBI www.sebi.gov.in and go to "Mutual Funds" section for information on
SEBI regulations and guidelines, data on mutual funds, draft offer documents filed by mutual funds, addresses of
mutual funds, etc. Also, in the annual reports of SEBI available on the web site, a lot of information on mutual
funds is given.
There are a number of other web sites which give a lot of information of various schemes of mutual funds
including yields over a period of time. Many newspapers also publish useful information on mutual fu nds on daily
and weekly basis. Investors may approach their agents and distributors to guide them in this regard.

32. Can an investor appoint a nominee for his investment in units of a mutual

fund?
Yes. The nomination can be made by individuals applying for / holding units on their own behalf singly or
jointly. Non-individuals including society, trust, body corporate, partnership firm, Karta of Hindu Undivided
Family, holder of Power of Attorney cannot nominate.

33. If mutual fund scheme is wound up, what happens to money invested?
In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of
expenses. Unit holders are entitled to receive a report on winding up from the mutual funds which gives all
necessary details.

34. How can the investors redress their complaints?

Investors would find the name of contact person in the offer document of the mutual fund scheme whom
they may approach in case of any query, complaints or grievances. Trustees of a mutual fund moni tor the
activities of the mutual fund. The names of the directors of Asset Management Company and Trustees are also
given in the offer documents. Investors should approach the concerned Mutual Fund / Investor Service Centre of
the Mutual Fund with their complaints,
If the complaints remain unresolved, the investors may approach SEBI for facilitating redressal of their
complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up
with it regularly. Investors may send their complaints to:
Securities and Exchange Board of India
Office of Investor Assistance and Education (OIAE)
Plot No.C4-A, ―G‖ Block, 1st Floor,
Bandra-Kurla Complex,
Bandra (E), Mumbai – 400 051

35. What is the procedure for registering a mutual fund with SEBI?
An applicant proposing to sponsor a mutual fund in India must submit an application in Form A along with a fee of
Rs. 1 lakh. The application is examined and once the sponsor satisfies certain conditions such as being in the
financial services business and possessing positive net worth for the last five years, having net profit in three out
of the last five years and possessing the general reputation of fairness and integrity in all business transactions, it
is required to complete the remaining formalities for setting up a mutual fund. These include inter alia, executing
the trust deed and investment management agreement, setting up a trustee company/board of trustees
comprising two- thirds independent trustees, incorporating the asset management company (AMC), contributing
to at least 40% of the net worth of the AMC and appointing a custodian. Upon satisfying these conditions, the
registration certificate is issued subject to the payment of registration fees of Rs. 25 lakhs. For details, see the
SEBI (Mutual Funds) Regulations, 1996.
Understand the Basics of Securities Markets
This tutorial would give you an overview of the Indian Securities Markets, understand the various processes
involved in Primary and Secondary Markets and also the schemes and products in Mutual Funds and Derivatives
Markets in India. It will also help you to know the steps in financial planning process.

1. Are you aware of the term ‗Securities‘ and ‗Securities Markets‘?

Securities are financial instruments issued to raise funds. The primary function of the securities markets is to
enable to flow of capital from those that have it to those that need it. Securities market help in transfer of
resources from those with idle resources to others who have a productive need for them. Securities markets
provide channels for allocation of savings to investments and thereby decouple these two activities. As a result,
the savers and investors are not constrained by their individual abilities, but by the economy‘s abilities to invest
and save respectively, which inevitably enhances savings and investment in the economy.

2. Do you know the concept of ‘Risk’ and ‘Return’?

Return refers to the benefit the investor will receive from investing in the security. Risk refers to the possibility that
the expected returns may not materialise. For example, a company may seek capital from an investor by issuing
a bond. A bond is a debt security, which means it represents a borrowing of the company. The security will be
issued for a specific period, at the end of which the amount borrowed will be repaid to the investor. The return
will be in the form of interest, paid periodically to the investor, at a rate and frequency specified in the
security. The risk is that the company may fall into bad times and default on the payment of interest or return of
principal.

3. Understand the Structure of Indian Securities Markets

The market in which securities are issued, purchased by investors, and subsequently transferred among
investors is called the securities market. The securities market has two interdependent and inseparable
segments, viz., the primary market and secondary market. The primary market, also called the new issue market,
is where issuers raise capital by issuing securities to investors. The secondary market also calle d the stock
exchange facilitates trade in already-issued securities, thereby enabling investors to exit from an investment. The
risk in a security investment is transferred from one investor (seller) to another (buyer) in the secondary markets.
The primary market creates financial assets, and the secondary market makes them marketable.

4. Who are the Issuers in Indian Securities Markets?

Issuers are organizations that raise money by issuing securities. They may have short-term and long-term need
for capital, and they issue securities based on their need, their ability to service the securities. Some of the
common issuers in the Indian Securities Markets are:

1. Companies issue securities to raise short and long term capital for conducting their business operations.

2. Central and state governments issue debt securities to meet their requirements for short and long term
funds to meet their deficits. Deficit is the extent to which the expense of the government is not met by its
income from taxes and other sources.

3. Local governments and municipalities may also issue debt securities to meet their development needs.
Government agencies do not issue equity securities.

4. Financial institutions and banks may issue equity or debt securities for their capital needs beyond their
normal sources of funding from deposits and government grants.

5. Public sector companies which are owned by the government may issue securities to public investors as
part of the disinvestment program of the government, when the government decides to offer its holding of
these securities to public investors.

6. Mutual funds issue units of a scheme to investors to mobilise money and invest them on behalf of investors
in securities.
5. What do Stock Brokers and Sub-brokers do in the Securities Markets?
Stock brokers are registered trading members of stock exchanges. They sell new issuance of securities to
investors. They put through the buy and sell transactions of investors on stock exchanges. All secondary market
transactions on stock exchanges have to be conducted through registered brokers. Sub-brokers help in reaching
the services of brokers to a larger number of investors. Several brokers provide research, analysis and
recommendations about securities to buy and sell, to their investors. Brokers may also enable screen-based
electronic trading of securities for their investors, or support investor orders over phone. Brokers earn a
commission for their services.

6. What is an Asset Management Company? What is the role of Portfolio

Managers?
Asset management company and portfolio managers are investment specialists who offer their services in
selecting and managing a portfolio of securities. Asset management companies are permitted to offer securities
(called units) that represent participation in a pool of money, which is used to create the portfolio. Portfolio
managers do not offer any security and are not permitted to pool the money collected from investors. They a ct on
behalf of the investor in creating and managing a portfolio. Both asset managers and portfolio managers charge
the investor a fee for their services, and may engage other security market intermediaries such as brokers,
registrars, and custodians in conducting their functions.

7. What role do Merchant Bankers perform in Securities Markets?

Merchant bankers also called as issue managers, investment bankers, or lead managers help an issuer access
the security market with an issuance of securities. They evaluate the capital needs, structure an appropriate
instrument, get involved in pricing the instrument, and manage the entire issue process until the securities are
issued and listed on a stock exchange. They engage other intermediaries such as registrars, brokers, bankers,
underwriters and credit rating agencies in managing the issue process.

8. What is the role of Underwriters in the Securities Markets?

Underwriters are primary market specialists who promise to pick up that portion of an offer of securities which
may not be bought by investors. They serve an important function in the primary market, providing the issuer the
comfort that if the securities being offered do not elicit the desired demand, the underwriters will step in and buy
the securities. The specialist underwriters in the government bond market are called primary dealers.

9. Know the role of Credit Rating Agencies in the Securities Markets.

Credit rating agencies evaluate a debt security to provide a professional opinion about the ability of the issuer to
meet the obligations for payment of interest and return of principal as indicated in the security. They use rating
symbols to rank debt issues, which enable investors to assess the default risk in a security.

10. What is the role of an Investment Adviser?

Investment adviser work with investors to help them make a choice of securities that they can buy, based on an
assessment of their needs, time horizon return expectation and ability to bear risk. They may also be involved in
creating financial plans for investors, where they define the goals for which investors need to save money and
propose appropriate investment strategies to meet the defined goals.

11. Know about the various regulators of the Indian Securities Markets.
Securities and Exchange Board of India (SEBI)
The Securities and Exchange Board of India (SEBI), a statutory body appointed by an Act of Parliament (SEBI
Act, 1992), is the chief regulator of securities markets in India. SEBI functions under the Ministry of Finance. The
main objective of SEBI is to facilitate growth and development of the capital markets and to ensure that the
interests of investors are protected. The Securities Contracts Regulation Act, 1956 is administered by SEBI.
SEBI has codified and notified regulations that cover all activities and intermediaries in the securities markets .
The Reserve Bank of India (RBI)
The Reserve Bank of India regulates the money market segment of securities market. As the manager of the
government‘s borrowing program, RBI is the issue manager for the government. It controls and regulates the
government securities market. RBI is also the regulator of the Indian banking system and ensures that banks
follow prudential norms in their operations. RBI also conducts the monetary, forex and credit policies, and its
actions in these markets influences the supply of money and credit in the system, which in turn impact the
interest rates and borrowing costs of banks, government and other issuers of debt securities.

12. Commonly used indicators while investing in Equity Markets.

a) Price Earning Multiple: The price-earnings ratio or the PE multiple is a valuation measure that
indicates how much the market values per rupee of earning of a company. It is computed as:
Market price per share/Earnings per share
Earnings per share are the profit after taxes divided by the number of shares. It indicates the amount of profit that
company has earned, for every share it has issued. PE is represented as a multiple. When one refers to a stock
was trading at 12x, it means the stocks is trading at twelve times its earnings.
b) Price to Book Value (PBV): The PBV ratio compares the market price of the stock with its book value. It is
computed as market price per share upon book value per share.
The book value is the accounting value per share, in the books of the company. It represents the net worth
(capital plus reserves) per share. If the market price of the stock were lower than the book value and the PBV is
less than one, the stock may be undervalued. In a bullish market when prices move up rapidly, the PBV would
drop, indicating rich valuation in the market.
c) Dividend Yield: Dividend is declared as a percentage of the face value of the shares. A 40% dividend
declared by company will translate into a dividend of Rs.4 per share with a face value of Rs 10 (10*40% =4). If
the share was trading in the stock market for a price of Rs.200 per share, this means a dividend yield of 2%.
The dividend declared by a company is a percentage of the face value of its shares. When the dividend received
by an investor is compared to the market price of the share, it is called the dividend yield of the share.

13. Do you know what Zero Coupon Bonds are?

A zero coupon bond does not pay any coupons during the term of the bond. The bond is issued at a discount to
the face value, and redeemed at face value. The effective interest earned is the difference between face value
and the discounted issue price. A zero coupon bond with a long maturity is issued at a very big discount to the
face value. Such bonds are also known as deep discount bonds.

14. Do you know what Floating Rate Bonds are?

Floating rate bonds are instruments where the interest rate is not fixed, but re-set periodically with reference to a
pre-decided benchmark rate. For instance, a company can issue a 5-year floating rate bond, with the rates being
reset semi-annually at 50 basis points above the 1- year yield on central government securities. Every six
months, the 1-year benchmark rate on government securities is ascertained from the prevailing market prices.
The coupon rate the company would pay for the next six months is calculated as this benchmark rate plus
50 basis points.
Floating rate bonds are also known as variable rate bonds and adjustable rate bonds.

15. Do you know what Callable Bonds and Puttable Bonds are?
Callable bonds allow the issuer to redeem the bonds prior to their original maturity date. Such bonds have a call
option in the bond contract, which lets the issuer alter the tenor of the security. For example, a 10 -year bond may
be issued with call options at the end of the 5th year such as in the SBI bond illustration below. Such options give
issuers more flexibility in managing their debt capital. If interest rates decline, an issuer can redeem a callable
bond and re-issue fresh bonds at a lower interest rate.
A Puttable bond gives the investor the right to seek redemption from the issuer before the original maturity date.
For example, a 7-year bond may have a put option at the end of the 5th year. If interest rates have risen, Puttable
bonds give investors the ability to exit from low-coupon bonds and re-invest in higher coupon bonds.

16. Know about the various Money Market Securities.

 a) Repos/reverse repos: A repo is a transaction in which one participant borrows money at a pre-determined
rate against the collateral of eligible security for a specified period of time. A reverse repo i s a lending transaction;
a repo in the books of the borrower is a reverse repo in the books of the lender. Eligible collateral for repos and
reverse repos are central and state government securities and select corporate bonds.
b) Collateralized Borrowing and Lending Obligation (CBLO): A Collateralized Borrowing and Lending
Obligation (CBLO) is an instrument used to lend and borrow for short periods, typically one to three days. The
debt is fully secured against the collateral of government securities. CBLO is a standardized and traded repo.
c) Certificates of Deposits (CDs): Certificates of Deposits (CDs) are short term tradable deposits issued by
banks to raise funds. CDs are different from regular bank deposits because they involve creation of sec urities.
This makes the CD transferable before maturity. However, actual trading in CDs is extremely limited with most
investors preferring to hold them to maturity.
d) Treasury Bills: The central government borrows extensively in the money market for its daily operations
through the issue of short-term debt securities called Treasury bills (T-bills). T-bills are issued for maturities of 91
days, 182 days and 364 days. They are issued through an auction process managed by the RBI and listed soon
after issue. Banks, mutual funds, insurance companies, provident funds, primary dealers and FIs bid in these
auctions.
e) Commercial Paper: Companies and institutions raise short-term funds in the money market through the
issue of commercial paper (CP). Though CPs are required to have a credit rating, they ar e unsecured corporate
loans with a limited secondary market. They can be issued for various maturities of up to 364 days, but the 90 -
day CP is the most popular.

17. Know the concept of Time Value of Money.

A rupee in hand today is more valuable than a rupee obtained in future. For example, let us compare receiving
Rs.1000 today, and receiving it after 2 years. If today‘s Rs.1000 is placed in a 2 year bank deposit earning simple
interest of 8%, then it will be worth Rs.1080 (principal 1000 + interest 80) at the end of 2 years. This makes
today‘s Rs.1000 more valuable than the future Rs.1000. The value of currently available funds over funds
received in the future is due to the return that can be earned by investing current funds. If cash flows that are
receivable at different points in time have to be compared, the time value of money has to be taken into account.

18. How are Bond Yields and prices related?

The bond price is the present value of cash inflows from the bond, discounted by the market yield. So bond price,
coupon rate and yield are all connected. Given any two, the third can be easily calculated.
In the bond markets, it is the price of a bond that is known and quoted. Information on coupon rate and
redemption are also available. Given the bond price and its coupon, the yield can be computed.
If the investor purchases the bond at a price lower than the face value, then he has acquired it at a price cheaper
than the originally issued price. As a result yield will be higher than the coupon rate. If the investor purchases the
bond at a price higher than the face value, then he has acquired it at a higher price than the original face value,
so his yield will be lower than the coupon rate.
There is an inverse relationship between yield and price of a bond. As bond price falls, the yield to the investor
goes up. This is because as the discounting rate (or yield) is increased, the final present value (price) reduces.

19. What is Yield to Maturity?

The rate which equates the present value of future cash flows from a bond with the current price of the bond is
called the Yield to Maturity (YTM) of the bond. As bond price changes, so does the YTM. Thus, YTM is the
discount rate implied in the bond value at a point in time. YTM is a popular and widely used meth od for
computing the return on a bond investment. Yield quotations in the debt market usually refer to YTM.

20. Do you know what an Initial Public Offer (IPO) is?

The first public offer of shares made by a company is called an Initial Public Offer (IPO). When a company makes
an IPO the shares of the company becomes widely held and there is a change in the shareholding pattern. The
shares which were privately held by promoters are now held by retail investors, institutions, promoters etc. An
IPO can either be a fresh issue of shares by the company or it can be an offer for sale to the public by any of the
existing shareholders, such as the promoters or financial institutions.

 Fresh Issue of Shares

 New shares are issued by the company to public investors. The issued share capital of the company increases.
The percentage holding of existing shareholders will come down due to the issuance of new shares .

 Offer for Sale

Existing shareholders such as promoters or financial institutions offer a part of their holding to the public
investors. The share capital of the company does not change since the company is not making a new issue of
shares. The proceeds from the IPO go to the existing shareholders who are selling the shares and not to the
company. The holding of the existing shareholders in the share capital of the company will reduce.

21. Do you know what a Follow-on Public Offer (FPO) is?

A follow-on public offer is made by an issuer that has already made an IPO in the past and now makes a further
issue of securities to the public. A company can make a further issue of shares if the aggregate of the proposed
issue and all the other issues made in a financial year does not exceed 5 times the pre-issue net worth.
When a company wants additional capital for growth or to redo its capital structure by retiring debt, it raises equity
capital through a fresh issue of capital in a follow-on public offer.

22. Do you know what Rights Issue of Shares is?

Whenever a company makes a fresh issue of shares, it has an impact on the existing shareholders since their
proportionate holding in the share capital of the company gets diluted. For example, a company may have 10
lakhs shares of Rs.10 each, amounting to an issued and paid-up capital of Rs. 1 crore. If it issues another 10
lakhs shares, to increase its capital, the proportion held by existing shareholders will come down by half, as the
issued and paid up capital has doubled. This is called as dilution of holdings. To prevent this, section 81 of the
Company‘s Act requires that a company which wants to raise more capital through an issue of shares must first
offer them to the existing shareholders. Such an offer of shares is called a rights issue.

23. What do you mean by the term ‘Green Shoe Option’?

The Green Shoe Option (GSO) in a public offer is used by companies to provide stability to price of the share in
the secondary market immediately on listing. A company, which opts for Green Shoe option can allot additional
shares not exceeding 15% of the issue size, to the general public who have subscribed in the issue. The
proceeds from this additional allotment will be kept in a separate bank account and used to buy shares in the
secondary markets once the shares are listed, in case the price falls below the issue price. This is expected to
provide support to the price of the shares. This price stabilization activity will be done by an entity appointed for
this purpose.

24. Do you know what a Mutual Fund is?

Mutual fund is a vehicle to mobilize moneys from investors, to invest in different markets and securities, in line
with the investment objectives agreed upon, between the mutual fund and the investors. In other words, through
investment in a mutual fund, a small investor can avail of professional fund management services offered by an
asset management company.

25. Are you aware of the Equity Mutual Funds?

Equity funds invest in a portfolio of equity shares and equity related instruments. The return and ri sk of the fund
will be similar to investing in equity. Investors in equity funds seek growth and capital appreciation as the primary
objective and should ideally have a long investment horizon that will allow time for the investment to appreciate in
value and not be affected by short-term fluctuations.

 Diversified equity funds invest across segments, sectors and sizes of companies. An index fund is a passive
diversified equity fund, invested in the same stocks in the same weighting as an equity market index. An
actively managed diversified equity fund modifies the weights across sectors, and may also choose non -index
stocks to outperform the index.

 Large- cap equity funds invest in stocks of large, liquid blue-chip companies with stable performance and
returns. The performance of a large stock fund is compared with a narrow index such as the Sensex or Nifty,
which the fund seeks to beat.
 Mid-cap funds invest in mid-cap companies that have the potential for greater growth and returns. However,
the risk in the funds is higher because the companies they invest in have a greater risk to their revenues and
profits.

 Small-cap funds invest in companies with small market capitalisation with intent of benefitting from the higher
gains in the price of stocks of smaller companies they may benefit from newer business opportunities. The
risks are also higher in small-cap funds.

 Sector funds invest in companies that belong to a particular sector such as technology or banking. The risk is
higher in sector funds because of lesser diversification since such stocks are by definition concentrated in a
particular sector.

 Thematic funds invest in stocks of companies which may be defined by a unifying underlying theme. For
example, infrastructure funds invest in stocks in the infrastructure sector, across construction, cement,
banking and logistics. They are more diversified than sector funds but more concentrated than a diversified
equity fund.

 Equity funds may also feature specific investment strategies. Value funds invest in stocks of good companies
selling at cheaper prices; dividend yield funds invest in stocks that pay a regular dividend; special situation
funds invest in stocks that show the promise of a turnaround.

26. Are you aware of the Debt Mutual Funds?

Debt funds invest in debt securities issued by the government, public sector units, banks and private limited
companies. Debt securities may have different features. They may have credit risk or risk of default, short -term or
long-term duration. Debt funds are offered in three broad categories:

 Short term funds:These funds focus primarily on accrual income and shorter maturity, and have a lower risk
and stable return.

i. Liquid funds can only invest in securities with not more than 91 days to maturity. This is a regulatory
requirement. These funds primarily earn coupon income in line with current market rates

ii. Ultra-short term funds hold a portfolio similar to liquid funds but with a slightly higher maturity to benefit
from higher coupon income.

iii. Short-term Gilt funds invest in short-term government securities such as treasury bills of the government.

iv. Short-Term Plan invest in a portfolio of short-term debt securities primarily to earn coupon income but may
also hold some longer term securities to benefit from appreciation in price.

 Long term funds:These funds focus on MTM gains and longer maturity, and have a higher risk and higher
return.

i. Gilt funds invest in a portfolio of long-term government securities. The coupon income earned is lower than
corporate bonds of comparable tenor since there is no credit risk in the securities. The MTM gains and
losses can be high since these securities have long tenors.

ii. Income funds invest in a combination of corporate bonds and government securities. They earn a higher
coupon income from the credit risk in corporate bonds held. The gains or losses from MTM will depend
upon the tenor of the securities held.

 Dynamic funds: These funds shift their focus between short and long term debt instruments,
depending on the expectation for interest rate, and provide moderately higher return than short term
funds, at a moderately lower risk than long term debt funds
 27. Do you know what are Fixed Maturity Plans?
Fixed Maturity Plans (FMP) are closed-end funds that invest in securities whose maturity matches the term of the
scheme. The scheme and the securities that it holds mature together at the end of the stated tenor. The fund
pays out the maturity proceeds of the portfolio on the closing date. Investors who are able to hold the scheme to
maturity will be able to benefit from the returns of the FMP that are locked in when the portfolio is created. There
is no risk of the value of the securities being lower at the time the fund matures (unless there is a default) since
the instruments will also be redeemed at their face value on maturity.

i. The time for which the investor is willing to invest must match the term of the fund

ii. The primary risk in FMPs is credit risk from a possible default by the issuer.

iii. As closed-end funds these schemes are listed on stock exchanges where they may be traded at prices
related to the NAV.

28. Do you know what Hybrid Funds are?

Hybrid funds hold a portfolio of equity and debt securities. The investment objective of the fund will determine the
allocation of the portfolio between the two asset classes. A hybrid fund is a debt and an equity fund, rolled into
one. The risk in a hybrid fund will primarily depend upon the allocation between equity and debt, and the relative
performance of these asset classes. The higher the equity component in the portfolio, the greater will be the
overall risk.

 Equity-Oriented Hybrid Funds

Equity-oriented hybrid funds have a greater exposure to equity in their portfolio as compared to debt. Balanced
funds are an example of equity-oriented funds. The coupon income from the debt portion will stabilize the risky
returns from the equity component. However the higher equity component in the portfolio means the fund‘s
overall returns will depend on the performance of the equity markets and will also fluctuate more.

 Debt-Oriented Hybrid Funds

Debt-oriented hybrid funds have a higher proportion of their portfolio allotted to debt. Monthly Income Plans are
such funds. The returns are primarily from the debt portion and will depend upon the type debt securities held:
short or long term, low or high credit risk. The equity portion augments the return from debt so that the fund is
able to generate better returns than a pure debt fund.

 Asset Allocation Funds

These funds invest in both equity and debt but without a pre-specified allocation as in the case of other hybrid
funds. The fund manager takes a view on which type of investment is expected to do well and will tilt the
allocation towards either asset class. Such funds may also hold 100% in equity or debt. Examples of asset
allocation fund include life stage funds that invest across asset classes suitable to the age of the investor. Such
funds will have a higher allocation to equity in the initial years and reduce equity exposure and increase debt
exposure as the age advances.

29. Do you know what Equity Linked Savings Schemes (ELSS) are?
Equity Linked Savings Schemes (ELSS) are equity funds that provide tax benefits in the form of deductions under
section 80 (c) for the amount invested.

 The limit for claiming deduction is Rs. One lakh.

 ELSS have to hold at least 80% of the investment portfolio in equity securities

 Investments are subject to a three-year lock-in on the investments made to get the tax benefit.

30. Do you know what are Exchange Traded Funds?

Exchange traded funds (ETF) are a type of mutual fund that combines features of an open-ended fund and a
stock. Following are its features:

 Units are issued directly to investors when the scheme is launched.

 Post this period, units are listed on a stock exchange like a stock and traded.

 Units purchased at the time of launch or bought from the stock markets are credited to the demat account of
the investor.

 Transactions are done through brokers of the exchange. Investors need a broking account and a demat
account to invest in ETFs.

 The prices of the ETF units on the stock exchange will be linked to the NAV of the fund, but prices are
available on a real-time basis depending on trading volume on stock exchanges.

31. Do you know what are Gold Exchange Traded Funds?

Gold Exchange Traded Funds (ETFs) are ETFs with gold as the underlying asset. The following are the features:

 It provides a way to hold gold in electronic rather than in physical form

 Typically each unit of ETF represents one gram of gold

 The fund holds physical gold and gold receipts representing the units issued

 Price of the units will move in line with the price of gold

32. Do you know what International Funds are?

International funds invest in securities listed on markets outside India. The type of securities that the fund can
invest in is specified by the regulator SEBI and includes equity shares and debt -listed abroad, units of mutual
funds and ETFs issued abroad and ADRs and GDRs of Indian companies listed abroad. The funds can also
invest part of the portfolio in the Indian markets.

33. Do you know what are Fund of Funds (FoFs)?

FoFs invests in other funds. The FoF selects funds that meets its investment objecti ves and invests in them. Its
portfolio is not made up of securities, but is a portfolio of other funds. Most FoFs invest in schemes of the same
mutual fund. Some FoFs consider schemes across fund houses which meets the FoFs investment objective for
inclusion in the portfolio.
An insight into various back-office operations activities in Securities
Markets
Securities Operations involves various middle office and back office operations of Securities Broking Firms. This
tutorial would give you an understanding of the basics of the Indian securities market, the different products
traded and the various market participants and the respective roles they play in the Indian securities market. It
would also help you know the various functions of the Front Office, Middle Office and Back Office in a Securiti es
Broking Firm, understand the trade life cycle, the steps and participants involved in the trade life cycle and the
role of the back office in a securities broking firm as well as understand how the risks are managed in a securities
broking firm, the clearing and settlement process.

1. What are the different products that are traded in the Indian
Securities Market?
The investors in the Indian securities market have a wide choice of product base to choose depending upon a
person‘s risk appetite and needs. Broadly, however the products available can be categorized as Debt and
Equity. We here discuss the different products available in the different types of market in India.
(a) Equity Markets and its Products
The equity segment of the stock exchange allows trading in shares, debentures, warrants, mutual funds and
exchange traded funds (ETFs).
Equity Shares represents the form of fractional ownership in a business venture. Equity shareholders collectively
own the company. They bear the risk and enjoy the rewards of ownership.
Debentures are instruments for raising long term debt. Debentures in India are typically secured by tangible
assets. There are fully convertible, non-convertible and partly convertible debentures. . Fully convertible
debentures will be converted into ordinary shares of the same company under specified terms and conditions.
Partly convertible debentures (PCDs) will be partly converted into ordinary shares of the same company under
specified terms and conditions. Thus it has features of both debenture as well as equity. Non Convertible
Debentures (NCDs) are pure debt instruments without a feature of conversion. The NCDs are repayable on
maturity. Partly Convertible debentures have features of convertible and non -convertible debentures. Thus,
debentures can be pure debt or quasi-equity, as the case may be.
Warrants entitle an investor to buy equity shares after a specified time period at a given price.
Mutual Funds are investment vehicles where people with similar investment objective come together to pool
their money and then invest accordingly. A mutual fund company pools money from many investors and invests
the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some
combination of these investments, depending on the objectives of the fund.
Exchange Traded Fund is a fund that can invest in either all of the securities or a representative sample of
securities included in the index. Importantly, the ETFs offer a one-stop exposure to a diversified basket of
securities that can be traded in real time like individual stock. Recently even ETF units with underlying security of
Gold are traded under this segment.
Indian Depository Receipt (IDR): Foreign companies are not allowed to directly list on the Indian stock
exchanges. However, they are now allowed to raise capital in Indian currency through an instrument called Indian
Depository Receipt (IDR). IDRs are issued by foreign companies to Indian investors. IDRs are depository receipts
which have the equity shares of the issuing company as the underlying security. The underlying shares are held
by a foreign custodian and the DRs are held in the Indian depository. IDRs are listed in the Indian stock
exchanges. The investor can either hold the IDR, trade in them in the stock exchange or request for redemption
into the underlying shares. Redemption is permitted after 1 year from the date of listing. SEBI has recently
permitted 2 way fungibility of IDRs. 2 way fungibility means the depository receipt can be converted into
underlying shares and underlying shares can be converted into depository receipt. However, the number of
shares that will be allowed to be converted into depository receipt should be within the headroom available.
Headroom shall mean number of IDRs issued less number of IDRs outstanding and IDRs already converted into
underlying shares.
(b) Derivative Market and its Products
Derivative is a product whose value is derived from the value of one or more basic variables, called bases
(underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex,
commodity or any other asset. The derivatives segment in India allows trading in the equities, currency,
commodities. There are two types of derivatives instruments viz., Futures and Options that are traded on the
Indian stock exchanges.
Index/Stock Future is an agreement between two parties to buy or sell an asset at a certain time in the future at
a certain price. Futures contracts are special types of forward contracts in the sense that the former are
standardized exchange-traded contracts. Futures contracts are available on certain specified stocks and indices.
Index / Stock Options are of two types - calls and puts. Calls give the buyer the right, but not the obligation, to
buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer
the right, but not the obligation, to sell a given quantity of the underlying asset at a given price on or before a
given date.
Currency Derivatives trading was introduced in the Indian financial markets with the launch of currency futures
trading in the USD-INR pair at the National Stock Exchange of India Limited on August 29, 2008. Few more
currency pairs have also been introduced thereafter. It was subsequently introduced in the BSE on October 1,
2008, and MCX-SX, On October 7, 2008. Currency futures are traded on the USD-INR, GBP-INR, EUR-INR and
JPY-INR at the NSE, MCX-SX and USE.
Commodity Derivatives markets are markets where raw or primary products are exchanged. These raw
commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized
contracts for a specified future date. Commodity markets facilitate the trading of commodities such as gold, silver,
metal, energy and agricultural goods.
Interest Rate Futures trading is based on notional 10 year coupon bearing GOI security. These contracts are
settled by physical delivery of deliverable grade securities using electronic book entry system of the existing
depository‘s viz., NSDL and CDSL and the Public Debt Office of the Reserve Bank unlike the cash settlement of
the other derivative products.
Derivatives on Foreign Stock Indices: SEBI in January 2011 has permitted the stock exchanges to introduce
derivative contracts (futures and options) on the foreign stock indices. The stock exchanges can introduce
derivative contracts on the foreign indices subject to certain eligibility criteria as mentioned in the SEBI guidelines
like market capitalization, volume of turnover, minimum number of constituent stocks and maximum weight of
single constituent in the index.
(c) Debt Market and its Products
Debt market consists of Bond markets, which provide financing through the issuance of Bonds, and enable the
subsequent trading thereof. Instruments like bonds/debentures are traded in this market. These instruments can
be traded in OTC or Exchange traded markets. In India, the debt market is broadly divided into two parts
government securities (G-Sec) market and the corporate bond market.
Government Securities Market: The Government needs enormous amount of money to perform various
functions such as maintaining law and order, justice, national defence, central banking, creation of physical
infrastructure. For this it generates revenue by various ways including borrowing from banks and other financial
institutions. One of the important sources of borrowing funds is the government securities market.
The government raises short term and long term funds by issuing securities. These securities do not carry default
risk as the government guarantees the payment of interest and the repayment of principal. They are therefore
referred to as gilt edged securities. Government securities are issued by the central government, state
government and semi government authorities. The major investors in this market are banks, insurance
companies, provident funds, state governments, FIIs. Government securities are of two types- treasury bills and
government dated securities. .
Corporate Bond Market: Corporate bonds are bonds issued by firms and are issued to meet needs for
expansion, modernization, restructuring operations, mergers and acquisitions. The corporate debt market is a
market wherein debt securities of corporates are issued and traded therein. The investors in this market are
banks, financial institutions, insurance companies, mutual funds, FIIs etc. Corporates adopt either the public
offering route or the private placement route for issuing debentures/bonds.
Other instruments available for trading in the debt segment are money market instruments like Treasury Bills,
Commercial Papers and Certificate of Deposits.

2. What is Trade Life Cycle (TLC)?

In financial market, ―trade‖ means to buy and / or sell securities / financial products. To explain it further, a trade
is the conversion of an order placed on the exchange which results into pay-in and pay-out of funds and
securities. Trade ends with the settlement of the order placed. Every trade has its own cycle and can be broken
down into pre-trade and post-trade events. Trading of securities also involves many participants like the
investors, brokers, exchange, clearing agency /corporation, clearing banks, depository participants, custodians
etc.
The following steps are involved in a trade‘s life cycle:

1. Placing of Order

2. Risk management and routing of order

 3. Order matching and its conversion into trade

4. Affirmation and Confirmation (only for institutional deals)

5. Clearing and settlement

3. How to place order on the trading system?

The Broker accepts orders from the client and sends the same to the Exchange after performing the risk
management checks. Clients have the option of placing their orders through various channels like internet, phone
etc.
In the year 2008, SEBI permitted the facility of Direct Market Access for institutional clients. DMA is a facility
which allows brokers to offer its institutional clients direct access to the exchange trading system through the
broker‘s infrastructure. This does not involve any manual intervention of the broker. This facility can be extended
to the institutional clients provided the broker satisfies the operational specifications; risk management measure
and other details as prescribed by SEBI.
Once the orders are received by the broker, it is confirmed with the client and then entered into the trading
system of the Exchange. The Exchange gives confirmation of the order and time stamps it. An order generally
comes with certain conditions which determine whether it is a market order, limit order etc. These specify the
terms and conditions at which the client wants his / her order to get executed.

4. What is Risk Management & Order Routing?

A sound risk management is integral to an efficient system. A broker‘s risk management works on the following
concepts:

 Cash: The broker normally ensures that there is enough balance in the clients account to honor the trade.

 In case a buy order is entered by the client/ on behalf of client, the broker‘s system queries to find the
available balance in the clients bank account and whether it is sufficient to meet the
stipulated margin requirements. This is as per the agreed upon terms and conditions of risk management with
the client. If the available balance satisfies the risk management parameters then the order is routed to the
exchange. In cases where the balance is not sufficient the order gets rejected. A rejection message is shown
in the system, which then is conveyed to client. In case there is no direct interface to a banking system, the
client is asked to maintain cash and securities deposit in order to ensure adequacy of balance.

 In case a client gives a sell order, the broker ensures that the client‘s custody/demat account has sufficient
balance of securities to honor the sale transaction; this is possible only if the client has his/her demat account
with the same broker. In all other cases, wherever the client has his demat account with an outside / third
party DP, it‘s the duty of the client to ensure that he has/ will have the required securities in the demat
account, before selling the same.

 Depending upon type of order and the actual prices prevailing in the market, the order gets executed
immediately or remains pending in the order book of the exchange.

5. How are Orders Matched and Converted into Trade?

All orders which are entered into the trading system of the Exchange are matched with similar counter orders and
are executed. The order matching in an exchange is done on a price time priority. The best price orders are
matched first. If more than one order is available at the same price then they are arranged in ascending time
order. Best buy price is the highest buy price amongst all orders and the best sell price is the lowest price of all
sell orders.
Once the order is matched it results into trade. As soon as the trade is executed, a trade confirmation message is
sent to the broker who had entered the order. The broker in turn lets the client know about the trade confirmation.
All orders which have not been executed, partly or fully can be modified or cancelled during the trading hours.
Trades done during the day can also be cancelled by mutual consent of both the parties subject to approval of
the Exchange. These generally occur due to order entry errors and are not a common practice.

6. How is Affirmation and Confirmation (For Institutional Clients)

done?
FIIs trading in the Indian securities market use the services of a custodian to assist them in the clearing and
settlement of executed trades. Custodians are clearing members of the exchange and not brokers who trade on
behalf of them. On behalf of their clients, they settle trades that have been executed through other brokers. A
broker assigns a particular trade to a custodian for settlement. The custodian needs to confirm whether he is
going to settle that trade. Upon confirmation the clearing corporations assigns the obligation to the custodian. The
overall risk that the custodian is bearing by accepting the trade is constantly measured against the collateral that
the institution submits to the custodian for providing this service.
It has been decided by SEBI that all the institutional trades executed on the stock exchanges would be
mandatorily processed through the Straight through Processing System (STP) w. e. f. July 01, 2004.

7. What is Straight through Processing (STP) System?

STP is a mechanism that automates the end-to-end processing of transactions of the financial instruments. It
involves use of a single system to process or control all elements of the work-flow of a financial transaction,
including what is commonly known as the Front, Middle, and Back office, and General Ledger. In other words,
STP can be defined as electronically capturing and processing transactions in one pass, from the point of first
‗deal‘ to final settlement.

8. What is known as Clearing and Settlement of trades?

Clearing and Settlement is a post trading activity that constitutes the core part of equity trade life cycles. After any
security deal is confirmed (when securities are obliged to change hands), the broker who is involved in the
transaction issues a contract note to the client which has all the information about the transactions in detail, at the
end of the trade day. In response to the contract note issued by broker, the client now has to settle his obligation
by either paying money (if his transaction is a buy transaction) or delivering the securities (if it is a sell
transaction).
Clearing house / corporation is an entity through which settlement of securities takes place. The details of all
transactions performed by the brokers are made available to the Clearing House/ Corporation by the Stock
Exchange. The Clearing House/ Corporation gives an obligation report to Brokers and Custodians who are
required to settle their money/securities obligations with the specified deadlines, failing which they are required to
pay penalties. This obligation report serves as statement of mutual contentment.

9. What is Pay-in and Pay-out?

Pay-In is a process whereby a stock broker and Custodian (in case of Institutional deals) bring in money and/or
securities to the Clearing House/ Corporation. This forms the first phase of the settlement activity.
Pay-Out is a process where Clearing House/ Corporation pays money or delivers securities to the brokers and
Custodians. This is the second phase of the settlement activity.
In India, the Pay-in of securities and funds happens on T+ 2 by 10.30 AM, and Pay-out of securities and funds
happen on T+2 by 1.30 PM.
The pay-in and pay-out days for funds and securities are prescribed as per the Settlement Cycle. A typical
Settlement Cycle of Normal Settlement is given below:

Activity Day

Trading Rolling Settlement Trading T

Clearing Custodial Confirmation T +1 working days

Delivery Generation T +1 working days

Settlement Securities and Funds pay in T+2 working days

 Securities and Funds pay out T+2 working days

Post Settlement Valuation Debit T+2 working days

Auction T+2 working days

Auction settlement T+3 working days

Bad Delivery Reporting T+4 working days

Rectified bad delivery pay-in and pay-out T+6 working days

Re-bad delivery reporting and pickup T+8 working days

Close out of re-bad delivery T+9 working days

10. What is the importance Risk Management in TLC?

A sound risk management system is integral to an efficient clearing and settlement system. The system must
ensure that brokers / trading member‘s obligations are commensurate with their networth.
Risk containment measures include capital adequacy requirements, margin requirements, position limits based
on capital, online monitoring of client positions etc. The main concepts of a Risk Management System are listed
below:

 There should be a clear balance available in the client‘s ledger account in the broker‘s books.

 The clients are required to provide margins upfront before putting in trade requests with the brokers.

 The aggregate exposure of the client‘s obligations should commensurate with the capital and networth of the
broker.

 The clients must settle the debits, if any, arising out of MTM settlements.

 In futures and options segment, the positions are allowed based on the margin available to satisfy initial
margin requirements of the Exchange. The clients are expected to pay the MTM margin as and when required
failing which the client or the broker may square off the trade.

11. What are Margin Requirements?

One of the critical components of risk management for the futures and options segment is the margining system.
The Exchange levies daily margin, Mark-to-Market (MTM) margin, Extreme loss margin in the equities segment
and initial margin and MTM margin in case of futures and options segment.
The broker needs to maintain upfront capital with the exchange to cover his daily margin at the time of order
placement. To ensure this, the broker collects upfront margin by way of funds/ shares from the client and
deposits the same with the exchange.

12. On what basis is margin requirements calculated?

On Gross Client Basis
The margin is required to be paid on the gross open position of the stock broker. The gross open position
signifies the gross of all net positions across all the clients of a member, including the proprietary position of the
member. Thus, it is important for the stock broker at any time to know the position on both gross and net basis for
all clients.
Two types of margins are applicable for option writing - initial margin and exposure margin.
The initial margin and the mark-to-market requirements are based on a worst-case scenario calculated by valuing
the portfolio under several scenarios of changes in market conditions over a trading day.
The market conditions taken into consideration involve combinations of possible changes in the spot price of the
underlying and changes in the volatility of the underlying. Sixteen possible scenarios are considered and
thereafter the margin requirements are specified.
 The margin requirements change considerably for the various stock options.

13. What is Mark-to-Market Margin?

Mark to market is calculated by marking each transaction in security to the closing price of the security at the end
of trading. In case the security has not been traded on a particular day, the latest available closing price is
considered as the closing price. In case the net outstanding position in any security is nil, the difference between
the buy and sell values shall be is considered as crystallized loss for the purpose of calculating the mark to
market margin payable.
The mark to market margin (MTM) is collected from the member before the start of the trading of the next day.
The MTM margin is collected/adjusted from/against the cash/cash equivalent component of the liquid net worth
deposited with the Exchange. The MTM margin is collected on the gross open position of the member. The gross
open position for this purpose means the gross of all net positions across all the clients of a member including
broker‘s proprietary position. For this purpose, the position of a client is netted across its various securities and
the positions of all the clients of a member are grossed.
There is no netting off of the positions and set-off against MTM profits across two rolling settlements i.e. T day
and T+1 day. However, for computation of MTM profits/losses for the day, netting or set-off against MTM profits
is permitted.

14. What is Value at Risk (VaR) Margining – Equity segment?

All securities are classified into three groups for the purpose of VaR margin.

 For the securities listed in Group I, scrip wise daily volatility calculated using the exponentially weighted
moving average methodology is applied to daily returns. The scrip wise daily VaR is 3.5 times the vol atility so
calculated subject to a minimum of 7.5%.

 For the securities listed in Group II, the VaR margin is higher of scrip VaR (3.5 sigma) or three times the index
VaR, and it is scaled up by root 3.

 For the securities listed in Group III the VaR margin is equal to five times the index VaR and scaled up by root
3.
The index VaR, for the purpose, is the higher of the daily Index VaR based on S&P CNX NIFTY or BSE
SENSEX, subject to a minimum of 5%.
The VaR margin rate computed as mentioned above is charged on the net outstanding position (buy value-sell
value) of the respective clients on the respective securities across all open settlements. There is no netting off of
positions across different settlements. The net position at a client level for a member is arrived at and thereafter,
it is grossed across all the clients including proprietary position to arrive at the gross open position.
The VaR margin is collected on an upfront basis by adjusting against the total liquid assets of the member at the
time of trade.
The VaR margin so collected is released on completion of pay-in of the settlement or on individual completion of
full obligations of funds and securities by the respective member/custodians after crystallization of the final
obligations on T+1 day.

15. What is Extreme Loss Margin?

The Extreme Loss Margin for any security is higher of 5%, or 1.5 times the standard deviation of daily logarithmic
returns of the security price in the last six months. This computation is done at the end of each month by taking
the price data on a rolling basis for the past six months and the resulting value is applicable for the next month.
The Extreme Loss Margin is collected/ adjusted against the total liquid assets of the member on a real time basis.
The Extreme Loss Margin is collected on the gross open position of the stock broker. The gross open position for
this purpose means the gross of all net positions across all the clients of a member including its proprietary
position.
There is no netting off of positions across different settlements. The Extreme Loss Margin collected is released
on completion of pay-in of the settlement or on individual completion of full obligations of funds and securities by
the respective broker/custodians after crystallization of the final obligations on T+1 day.
The risk management practices undertaken by members for currency derivatives trading, is similar to those for
derivatives trading in equities.

16. What is clearing Process of trades?

At the end of the trading day, the transactions entered into by the brokers are tallied to determine the total
amount of funds and/or securities that the stock broker needs either to receive or to pay. This process is called
clearing. In the stock exchanges this is done by a process called multilateral netting. This process is performed
by clearing corporation.
The clearing agency guarantees that all contracts which are traded will be honoured. Clearing therefore serves to
create a more efficient market, since all the players involved need not include the original counterparty risk in the
price calculation. Generally, the clearing and settlement process can be classified into: Matching, Central
counterparty, Cash settlement and Delivery.
Matching means that the parties agree on the conditions of the transaction, i.e. what has been bought or sold,
price, quantity, etc. ‗Central counterparty clearing‘ is when the clearing organization becomes the legal
counterparty in a transaction. Cash settlement refers to settlement of premiums, fees, mark-to-market and other
cash settlements, and delivery of the underlying instrument or cash settlement occurs after expiration or
premature exercise.

17. What is Settlement Process?

(a) How is settlement obligations in Equity segment determined?
Clearing Corporation receives the details of trades and prices from the exchange. Settlement obligations are
computed using predefined methodology specified for the segment/product. Some of the methods of determining
obligations are listed below:
a) Netted obligation: All purchase & sell transactions will be netted to determine the obligations. Member will
have obligation to deliver a security in a settlement only if the sell quantity is more than buy quantity. Similarly, in
case buy quantity is more than sell quantity, the member will receive a pay-out of the security. Fund obligations
will also be computed on a netted basis across all securities under netted settlement.
b) Trade to trade or Gross obligations: Transactions will not be netted to determine obligations. Member‘s
security pay-in obligation will be equivalent to cumulative sell quantity and security pay-out will be equivalent to
cumulative buy quantity. Funds pay-in will be equivalent to cumulative value of buy transactions and funds pay-
out will be equivalent to cumulative sell value.
c) Daily mark to market settlement of futures contract: Daily settlement prices will computed for futures
contracts based on specified methodology. All open positions will be marked to market at the settlement prices to
determine mark to market obligations to be settled in cash. All open positions will be carried forward at the latest
daily settlement prices.

(b) What are the timings for Settlement of Funds?

The Clearing Bank debits the settlement accounts of the members maintained with the bank within 10.30 a.m. on
the last date of settlement period. This appears in the Member‘s Balance Sheet.
The Clearing Bank credits the settlement accounts of the members maintained with the bank by 1:30 p.m. on the
last date of Settlement period. This appears as net receivable in the Members Balance Sheet.
Overview of Indian Securities Markets
The Indian Securities Market is one of the leading markets in the emerging world. Over the past few years, the
financial markets have become increasingly global. The Indian market has gained from foreign inflows through
the investment of Foreign Institutional Investors (FIIs). Following the implementation of reforms in the securities
industry in the past few years, Indian stock markets have stood out in the world ranking. As per Standard and
Poor‘s Fact Book 2012, India ranked 11th in terms of market capitalization, 17th in terms of total value traded in
stock exchanges, and 30th in terms of turnover ratio, as of December 2011.
The securities market has essentially three categories of participants—the issuer of the securities, the investors
in the securities, and the intermediaries. The issuers are the borrowers or deficit savers, who issue securities to
raise funds. The investors, who are surplus savers, deploy their savings by subscribing to these securities. The
intermediaries are the agents who match the needs of the users and the suppliers of funds for a commission.
These intermediaries function to help both the issuers and the investors to achieve their respective goals. There
are a large variety and number of intermediaries providing various services in the Indian sec urities market (Table
1-3). This process of mobilizing the resources is carried out under the supervision and overview of the regulators.
The regulators develop fair market practices and regulate the conduct of the issuers of securities and the
intermediaries. They are also in charge of protecting the interests of the investors. The regulator ensures a high
service standard from the intermediaries, as well as the supply of quality securities and non-manipulated demand
for them in the market.

As on Sep
Market Participants FY 2011 FY 2012 30, 2012

Securities Appellate Tribunal (SAT) 1 1 1

Regulators* 4 4 4

Depositories 2 2 2

Stock Exchanges

With Equities Trading 19 19 19

With Debt Market Segment 2 2 2

With Derivative Trading 2 2 2

With Currency Derivatives 4 4 4

Brokers (Cash Segment) 10203 10268 10165

Corporate Brokers (Cash Segment) 4774 4877 4827

Brokers (Equity Derivatives) 2111 2337 2416

Brokers (Currency Derivatives) 2008 2173 2201

Sub-brokers 83808 77141 74224

FIIs 1722 1765 1753

Portfolio Managers 267 250 251

Custodians 17 19 19

Registrars to an issue & Share Transfer

Agents 73 74 75

Merchant Bankers 192 200 202

Bankers to an Issue 55 57 57

Debenture Trustees 29 31 31

Underwriters 3 3 3

Venture Capital Funds 184 212 211

 As on Sep
Market Participants FY 2011 FY 2012 30, 2012

Foreign Venture Capital Investors 153 176 182

Mutual Funds 51 49 49

Collective Investment Schemes 1 1 1

KYC Registration Agency (KYC) - - 4

*DCA, DEA, RBI & SEBI

Source: SEBI

The securities market has two interdependent and inseparable segments, namely, the new issues (primary)
market and the stock (secondary) market. The primary market provides the channel for the creation and sale of
new securities, while the secondary market deals in the securities that were issued previously. The securities
issued in the primary market are issued by public limited companies or by government agencies. The resources
in this kind of market are mobilized either through a public issue or through a private placement route. If anybody
can subscribe for the issue, it is a public issue; if the issue is made available only to a select group of people, it is
known as private placement. There are two major types of issuers of securities —corporate entities, who issue
mainly debt and equity instruments, and the government (central as well as state), which issues debt securities
(dated securities and treasury bills).
The secondary market enables participants who hold securities to adjust their holdings in response to changes in
their assessment of risks and returns. Once new securities are issued in the primary market, they are traded in
the stock (secondary) market. The secondary market operates through two mediums, namely, the over -the-
counter (OTC) market and the exchange-traded market. The OTC markets are informal markets where trades are
negotiated. Most of the trades in government securities take place in the OTC market. All the spot trades where
securities are traded for immediate delivery and payment occur in the OTC market. The other option is to trade
using the infrastructure provided by the stock exchanges. The exchanges in India follow a systematic settlement
period. All the trades taking place over a trading cycle (day = T) are settled together after a certain time (T + 2
day). The trades executed on exchanges are cleared and settled by a clearing corporation. The clearing
corporation acts as a counterparty and guarantees settlement. A variant of the secondary market is the forward
market, where securities are traded for future delivery and payment. A variant of the forward market is the
Futures and Options market. Presently, only two exchanges in India —the National Stock Exchange of India Ltd.
(NSE) and the Bombay Stock Exchange (BSE)—provide trading in Futures and Options.