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IPO
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Mutual Funds
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Equity
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Commodity
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Derivatives
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IPO |
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1) What is IPO |
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2) About Public Issues?
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3) More about Book Building?
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1) What is IPO?
An initial public offering, or IPO, is the first sale of stock
by a company to the public. A company can raise money by issuing either debt or
equity. If the company has never issued equity to the public, it's known as an IPO.
An IPO is also sometimes known as "going public." Technically,
an IPO is the offering to sell but virtually all IPOs result in all the stock offered
being sold. IPOs are generally managed by companies that specialize in handling
IPOs and have experience in determining what the likely IPO offering price should
be. If the IPO manager determines that the stock will not sell at an offering price
that is acceptable to the company, the application for an IPO is usually withdrawn
until a better time. As soon as all shares of an IPO have been sold, the stock is
now tradable through stock exchanges or specialists that trade in the stock and
the stock price may go up or down.
Basis of Allotment or Basis of Allocation is a document
publishes by registrar of an IPO to stock exchanges and IPO investors. This document
provides information about final price fixed for an IPO, issue subscription (bidding)
information or demand of an IPO and share allocation ratio.
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2) About Public Issues?
Corporates may raise capital in the primary market by way of
an initial public offer, rights issue or private placement. An Initial Public Offer
(IPO) is the selling of securities to the public in the primary market. This Initial
Public Offering can be made through the fixed price method, book building method
or a combination of both.
There are two types of Public Issues
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ISSUE TYPE
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OFFER PRICE |
DEMAND |
PAYMENT |
RESERVATIONS |
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Fixed Price Issues |
Price at which the securities are offered and would be allotted is made known in
advance to the investors |
Demand for the securities offered is known only after the closure of the issue |
100 % advance payment is required to be made by the investors at the time of application. |
50 % of the shares offered are reserved for applications below Rs. 1 lakh and the
balance for higher amount applications. |
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Book Building Issues |
A 20 % price band is offered by the issuer within which investors are allowed to
bid and the final price is determined by the issuer only after closure of the bidding. |
Demand for the securities offered , and at various prices, is available on a real
time basis on the BSE website during the bidding period.. |
10 % advance payment is required to be made by the QIBs along with the application,
while other categories of investors have to pay 100 % advance along with the application. |
50 % of shares offered are reserved for QIBS, 35 % for small investors and the balance
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3) More about Book Building?
Book Building is essentially a process used by companies raising
capital through Public Offerings-either Initial Public Offers (IPOs) or Follow-on
Public Offers (FPOs) to aid price and demand discovery. It is a mechanism where,
during the period for which the book for the offer is open, the bids are collected
from investors at various prices, which are within the price band specified by the
issuer. The process is directed towards both the institutional as well as the retail
investors. The issue price is determined after the bid closure based on the demand
generated in the process.
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The Process:
• The Issuer who is planning an offer nominates lead merchant
banker(s) as 'book runners'.
• The Issuer specifies the number of securities to be issued and the price band
for the bids.
• The Issuer also appoints syndicate members with whom orders are to be placed by
the investors.
• The syndicate members input the orders into an 'electronic book'. This process
is called 'bidding' and is similar to open auction.
• The book normally remains open for a period of 5 days.
• Bids have to be entered within the specified price band.
• Bids can be revised by the bidders before the book closes.
• On the close of the book building period, the book runners evaluate the bids on
the basis of the demand at various price levels.
• The book runners and the Issuer decide the final price at which the securities
shall be issued.
• Generally, the numbers of shares are fixed; the issue size gets frozen based on
the final price per share.
• Allocation of securities is made to the successful bidders. The rest get refund
orders.
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Mutual Funds |
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1) What is 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.
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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.
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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.
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2) What is the history of Mutual Funds in India
and role of SEBI in mutual funds industry?
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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.
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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.
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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.
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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.
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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.
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5) What are the different types of mutual
fund schemes?
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.
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.
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, S&P 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.
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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.
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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.
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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.
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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 units 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 can enter the fund/scheme at NAV and no additional charges
are payable on purchase or sale of units.
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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.
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11) What is a sales 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.
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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
document.
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 at
the beginning of the next year.
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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.
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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 days,
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.
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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.
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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.
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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.
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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.
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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.
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20) How long will it take for transfer
of units after purchase from stock markets in case of close-ended schemes?
The performance of a particular scheme of a mutual fund is
denoted by Net Asset Value (NAV).
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.
There are also exchange traded index funds launched by the
mutual funds which are traded on the stock exchanges.
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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).
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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.
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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.
There are also exchange traded index funds launched by the
mutual funds which are traded on the stock exchanges.
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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.
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25) How to know where the mutual fund scheme
has invested money mobilised 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.
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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.
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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.
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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.
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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 mobilise funds from the investors by
launching schemes only after getting registered with SEBI as mutual funds.
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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.
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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 funds on daily and weekly basis.
Investors may approach their agents and distributors to guide them in this regard.
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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.
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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.
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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 monitor 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 Center 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)
Exchange Plaza, “G” Block, 4th Floor,
Bandra-Kurla Complex,
Bandra (E), Mumbai – 400 051.
Phone: 26598510-13
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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.25,000. 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.25.00 lacs For details, see the SEBI (Mutual Funds) Regulations, 1996.
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Equity
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• Stock markets, which facilitates equity investment and buying and selling of shares
of stock. Bond markets, which provides financing through the issue of debt contracts
and the buying and selling of bonds and debentures. • Money markets, which provides
short term debt financing and investment.
• Derivatives markets, which provides instruments for handling of financial risks.
• Futures markets, which provide standardized contracts for trading assets at a
forthcoming date.
• Insurance markets, which facilitates handling of various risks.
• Foreign exchange markets
These markets can be either primary markets or aftermarkets.
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3) What is Stock Market?
A stock market is a market for
the trading of publicly held company stock and associated financial instruments
(including stock options, convertibles and stock index futures).
Many years ago, worldwide, buyers and sellers were individual investors and businessmen.
These days markets have generally become "institutionalized"; that is, buyers and
sellers are largely institutions whether pension funds, insurance companies, mutual
funds or banks. This rise of the institutional investor has brought growing professionalism
to all aspects of the markets.
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4) What is Money Market?
The money market is a subsection
of the fixed income market. We generally think of the term "fixed income" as a synonym
of bonds. In reality, a bond is just one type of fixed income security. The difference
between the money market and the bond market is that the money market specializes
in very short-term debt securities (debt that matures in less than one year). Money
market investments are also called cash investments because of their short maturities.
Money market securities are essentially IOUs (an abbreviation of the phrase "I owe
you") issued by governments, financial institutions and large corporations. These
instruments are very liquid and considered extraordinarily safe. Since they are
extremely conservative, money market securities offer significantly lower returns
than most of the other securities.
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5) Who are the main participants in the capital market?
The capital market framework consists
of the following participants:
• Stock Exchanges
• Market intermediaries, such as stock-brokers and Mutual Funds
• Investors
• Regulatory institutions (e.g. SEBI)
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6) Who are the main participants in the capital market?
The following are the different
types of financial instruments-
Debentures
A debenture is the most common form of long-term loan taken by a company. It is
usually a loan repayable at a fixed date, although some debentures are irredeemable
securities; these are sometimes called perpetual debentures. Most debentures also
pay a fixed rate of interest, and this interest must be paid before a dividend is
paid to shareholders.
Bonds
A bond is a debt investment with which the investor loans money to an entity (company
or government) that borrows the funds for a defined period of time at a specified
interest rate.
Preference shares
Preferential shareholders enjoy a preferential right over equity shareholders with
regards to: Receipt of dividend
Receipt of residual funds after liquidation
However, preferential shareholders do not have voting rights; they are entitled
only to a fixed dividend.
Equity shares
Equity shares represent proportionate ownership in a company. Investors who own
equity shares in a company are entitled to ownership rights, such as:
• Share in the profits of the company (in the form of dividends)
• Share in the residual funds after liquidation / winding up of the company
• Selection of directors in the board, etc.
Government Securities
The Central Government and the State Governments issue securities periodically for
the purpose of raising loans from the public. There are 2 main types of Government
securities:
Dated Securities: have a maturity period of more than 1 year
Treasury Bills: have a maturity period of less than 1 year
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7) How do I buy financial instruments as investment options?
One cannot buy directly from the
market or stock exchange. A buyer has to buy stocks or equity through a Stock Broker,
who is a registered authority to deal in equities of various companies. In effect
a lot many intermediaries might come in between the buyer and seller, as brokers
do their business through many sub-brokers and the like.
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8) How risky is the Stock Market?
The general theory goes that the
higher the profit, the greater the risk. Since there is scope for high profit in
the Stock Market, investing in the Stock Market can be risky. In fact, more than
80% of the people who put money in the market lose it and a majority of the rest
are barely able to protect themselves from losses. Only a minuscule minority of
investors are able to garner any substantive profits.
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9) If Stock Market is so risky, why are people in it?
Basic human psychology. Men want
profits- big and fast. Not many are deterred by the risks involved. The fact is
that investment in the stock markets can give, potentially, the fastest ROI (Return
On Investment), as the value of a stock can rise pretty fast, ensuring huge profit
for investor. People buy shares in a company for either of two reasons:
• They have a stake in the company. They are concerned not only in the future growth
in stock value but in the worth of the company itself. Their investments are long-term
and they don't sell their shares in an impulse.
• They want quick profit and don't have any stake or interest in the company, but
merely want some quick value addition. Most investors belong to this category. Their
investments - both buying and selling - are impulsive. Mostly, they don't do any
market research and don't follow any sector or company to gain proper knowledge
before investing.
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10) How can I achieve success in stock market?
The precept is very easy their
investment, saving your investment is the first and most important part. This can
be done by ensuring that you do not put your money in a company that does not show
solid prospects. Fly- by- nights companies or companies whose shares touch the roof
suddenly, need to be avoided. Companies that show a steady prospect are good to
invest in. Needless to say, this process involves close acquaintance with market
movements and a thorough understanding of the concepts involved. You should know
when to dump your shares especially when they are becoming just junk papers.
The second thing is that adequate market knowledge is very
important especially when you have invested in the stock market. One should be patient
and judiciously responsive to market swings. Of course, luck is also a major factor.
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11) What is the best suggestion for investment?
Undoubtedly, it is 'Don't put all
your eggs in the same basket'. It is very tempting to make all your investment in
the same sector when their stocks are going up, but since market trends are very
volatile, you are, at the same time, making yourself extremely vulnerable to lose
all your money. Dealing with single sector investment requires razor sharp timing
with zero margin for error - a tall order in such a speculative and volatile business.
Hence, it is always advisable to make investments in different companies and in
different sectors, so that you can achieve stable portfolio diversification and
compensate losses in one sector against profits in an another sector.
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Commodity
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Hedgers: Hedgers enter into commodity contracts to be assured access to a
commodity, or the ability to sell it, at a guaranteed price. They use futures to
protect themselves against unanticipated fluctuations in the commodity's price.
Speculators: Speculators are participants who wish to bet on future movements
in the price of an asset. Individuals, willing to absorb risk, trade in commodity
futures as speculators. Speculating in commodity futures is not for people who are
averse to risk. Unforeseen forces like weather can affect supply and demand, and
send commodity prices up or down very rapidly. As a result of this leveraged speculative
position, they increase the potential for large gains as well as large losses.
Arbitrageur: A type of investor who attempts to profit from price inefficiencies
in the market by making simultaneous trades that offset each other and capture risk-free
profits. Arbitrageurs constitute a group of participants who lock themselves in
a risk-less profit by simultaneously entering into transactions in two or more contracts
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4) How do Commodity prices move?
The following factors have an impact
the commodity prices:
• Demand & Supply
• Natural Factors: Soil and climatic conditions, natural calamities etc.
• Government Policies - e.g. EXIM Policies like tariff rates, minimum support prices
• Annual production, consumption and carry-over quantity of stocks
• Economic policies and conditions:
• Interest Rates - e.g. hike in federal rates bring down the dollar, thereby increasing
lucrative-ness of investment in precious metals.
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5) Indian Commodity Market?
• Supply – Worlds leading producer
of 17 Agri Commodities
• Demand – Worlds , major market of Bullion, Foodgrains, Edible oils, Fibers, Spicies
and plantation crops.
• GDP Driver – Predominantly an AGRARIAN Economy
• Captive Market – Agro products produced and consumed locally
• Width and Spread – Over 30 major markets and 5500 Mandies
• Waiting to Explode – Value of production around Rs. 3,00,000 crore and expected
futures market potential around Rs. 30,00,000 crore.
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6) Who regulates the Indian Commodity Future Market ?
Just as SEBI regulates the stock exchanges, commodity exchanges
are regulated by the Forwards Market Commission (FMC), which comes under the purview
of the Ministry of Food, Agriculture and Public Distribution
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7) What are the major commodity exchanges?
• Multi-Commodity Exchange of India
Ltd, Mumbai (MCX).
• National Commodity and Derivatives Exchange of India, Mumbai (NCDEX).
• National Multi Commodity Exchange, Ahemdabad (NMCE).
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8) What are the commodity derivatives market timings?
Monday to Friday: 10 am to 11.30
pm (Agri-commodities up to 5 p.m. only) Saturday: 10 am to 2 pm
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9) Is delivery of commodities available? Is it compulsory?
Yes, but its not compulsory, buyers
and sellers intending to take/give delivery should express their intention to the
exchange. The exchange will match delivery randomly and assign it accordingly.
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Derivatives
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1) What are Derivatives?
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2) What is a Futures Contract?
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3) What is an Option contract?
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4) What are Index Futures and
Index Option Contracts?
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5) What is the structure of Derivative
Markets in India? |
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6) What is the regulatory framework
of Derivatives markets in India? |
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7) What derivative contracts
are permitted by SEBI?
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8) What is the eligibility criteria
for stocks on which derivatives trading may be permitted? |
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9) What is minimum contract
size? |
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10) What is the lot size of a
contract? |
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11) What is corporate adjustment? |
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12) What is the margining system
in the derivative markets? |
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13) What are Market wide position
limits for single stock futures and stock option Contracts?
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14) What measures have been specified
by SEBI to protect the rights of investor in Derivatives Market? |
1) What are Derivatives?
The term "Derivative" indicates
that it has no independent value, i.e. its value is entirely "derived" from the
value of the underlying asset. The underlying asset can be securities, commodities,
bullion, currency, live stock or anything else. In other words, Derivative means
a forward, future, option or any other hybrid contract of pre determined fixed duration,
linked for the purpose of contract fulfillment to the value of a specified real
or financial asset or to an index of securities. With Securities Laws (Second Amendment)
Act,1999, Derivatives has been included in the definition of Securities. The term
Derivative has been defined in Securities Contracts (Regulations) Act, as:- A Derivative
includes: -
a security derived from a debt instrument, share, loan, whether secured or unsecured,
risk instrument or contract for differences or any other form of security a contract
which derives its value from the prices, or index of prices, of underlying securities
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2) What is a Futures Contract?
Futures Contract means a
legally binding agreement to buy or sell the underlying security on a future date.
Future contracts are the organized/standardized contracts in terms of quantity,
quality (in case of commodities), delivery time and place for settlement on any
date in future. The contract expires on a pre-specified date which is called the
expiry date of the contract.
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On expiry, futures can be settled by delivery of the underlying asset or cash. Cash
settlement enables the settlement of obligations arising out of the future/option
contract in cash.However so far delivery against future contracts have not been introduced
and the future contract is settled by cash settlement only.
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3) What is an Option contract?
Options Contract is a type of Derivatives
Contract which gives the buyer/holder of the contract the right (but not the obligation)
to buy/sell the underlying asset at a predetermined price within or at end of a
specified period. The buyer / holder of the option purchases the right from the
seller/writer for a consideration which is called the premium. The seller/writer
of an option is obligated to settle the option as per the terms of the contract
when the buyer/holder exercises his right. The underlying asset could include securities,
an index of prices of securities etc. Under Securities Contracts (Regulations) Act,1956
options on securities has been defined as "option in securities" means a contract
for the purchase or sale of a right to buy or sell, or a right to buy and sell,
securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put,
a call or a put and call in securities;
An Option to buy is called Call option and option to sell is called Put option.
Further, if an option that is exercisable on or before the expiry date is called
American option and one that is exercisable only on expiry date, is called European
option. The price at which the option is to be exercised is called Strike price
or Exercise price.
Therefore, in the case of American options the buyer has the right to exercise the
option at anytime on or before the expiry date. This request for exercise is submitted
to the Exchange, which randomly assigns the exercise request to the sellers of the
options, who are obligated to settle the terms of the contract within a specified
time frame. As in the case of futures contracts, option contracts can also be settled
by delivery of the underlying asset or cash. However, unlike futures cash settlement
in option contract entails paying/receiving the difference between the strike price/exercise
price and the price of the underlying asset either at the time of expiry of the
contract or at the time of exercise / assignment of the option contract. However
so far delivery against option contracts have not been introduced and the option
contract, on exercise or expiry, is settled by cash settlement only.
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4) What are Index Futures and Index Option Contracts?
Futures contract based on an index
i.e. the underlying asset is the index,are known as Index Futures Contracts. For
example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive
their value from the value of the underlying index. Similarly, the options contracts,
which are based on some index, are known as Index options contract. However, unlike
Index Futures, the buyer of Index Option Contracts has only the right but not the
obligation to buy / sell the underlying index on expiry. Index Option Contracts
are generally European Style options i.e. they can be exercised / assigned only
on the expiry date. An index, in turn derives its value from the prices of securities
that constitute the index and is created to represent the sentiments of the market
as a whole or of a particular sector of the economy. Indices that represent the
whole market are broad based indices and those that represent a particular sector
are sectoral indices.
In the beginning futures and options were permitted only on S&P Nifty and BSE Sensex.
Subsequently, sectoral indices were also permitted for derivatives trading subject
to fulfilling the eligibility criteria. Derivative contracts may be permitted on
an index if 80% of the index constituents are individually eligible for derivatives
trading. However, no single ineligible stock in the index shall have a weightage
of more than 5% in the index. The index is required to fulfill the eligibility criteria
even after derivatives trading on the index has begun. If the index does not fulfill
the criteria for 3 consecutive months, then derivative contracts on such index would
be discontinued. By its very nature, index cannot be delivered on maturity of the
Index futures or Index option contracts therefore, these contracts are essentially
cash settled on Expiry.Therefore index options are the European options while stock
options are American options.
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5) What is the structure of Derivative Markets in India?
Derivative trading in India takes
can place either on a separate and independent Derivative Exchange or on a separate
segment of an existing Stock Exchange. Derivative Exchange/Segment function as a
Self-Regulatory Organisation (SRO) and SEBI acts as the oversight regulator. The
clearing & settlement of all trades on the Derivative Exchange/Segment would have
to be through a Clearing Corporation/House, which is independent in governance and
membership from the Derivative Exchange/Segment.
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6) What is the regulatory framework of Derivatives markets in India?
With the amendment in the definition
of 'securities' under SC(R)A (to include derivative contracts in the definition
of securities), derivatives trading takes place under the provisions of the Securities
Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India
Act, 1992.
Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework
for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative
Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions
for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations
of the Derivative Segment of the Exchanges and their Clearing Corporation/House
have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility
conditions for Derivative Exchange/Segment and its Clearing Corporation/House. The
eligibility conditions have been framed to ensure that Derivative Exchange/Segment
& Clearing Corporation/House provide a transparent trading environment, safety &
integrity and provide facilities for redressal of investor grievances. Some of the
important eligibility conditions are-
• Derivative trading to take place through an on-line screen based Trading System.
• The Derivatives Exchange/Segment shall have on-line surveillance capability to
monitor positions, prices, and volumes on a real time basis so as to deter market
manipulation.
• The Derivatives Exchange/ Segment should have arrangements for dissemination of
information about trades, quantities and quotes on a real time basis through atleast
two information vending networks, which are easily accessible to investors across
the country.
• The Derivatives Exchange/Segment should have arbitration and investor grievances
redressal mechanism operative from all the four areas / regions of the country.
• The Derivatives Exchange/Segment should have satisfactory system of monitoring
investor complaints and preventing irregularities in trading.
• The Derivative Segment of the Exchange would have a separate Investor Protection
Fund.
• The Clearing Corporation/House shall perform full novation, i.e., the Clearing
Corporation/House shall interpose itself between both legs of every trade, becoming
the legal counterparty to both or alternatively should provide an unconditional
guarantee for settlement of all trades.
• The Clearing Corporation/House shall have the capacity to monitor the overall
position of Members across both derivatives market and the underlying securities
market for those Members who are participating in both.
• The level of initial margin on Index Futures Contracts shall be related to the
risk of loss on the position. The concept of value-at-risk shall be used in calculating
required level of initial margins. The initial margins should be large enough to
cover the one-day loss that can be encountered on the position on 99% of the days.
• The Clearing Corporation/House shall establish facilities for electronic funds
transfer (EFT) for swift movement of margin payments.
• In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House
shall transfer client positions and assets to another solvent Member or close-out
all open positions.
• The Clearing Corporation/House should have capabilities to segregate initial margins
deposited by Clearing Members for trades on their own account and on account of
his client. The Clearing Corporation/House shall hold the clients' margin money
in trust for the client purposes only and should not allow its diversion for any
other purpose.
• The Clearing Corporation/House shall have a separate Trade Guarantee Fund for
the trades executed on Derivative Exchange / Segment.
Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE
and the F&O Segment of NSE.
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7) What derivative contracts are permitted by SEBI?
Derivative products have been introduced
in a phased manner starting with Index Futures Contracts in June 2000. Index Options
and Stock Options were introduced in June 2001 and July 2001 followed by Stock Futures
in November 2001. Sectoral indices were permitted for derivatives trading in December
2002. Interest Rate Futures on a notional bond and T-bill priced off ZCYC have been
introduced in June 2003 and exchange traded interest rate futures on a notional
bond priced off a basket of Government Securities were permitted for trading in
January 2004.
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8) What is the eligibility criteria for stocks on which derivatives trading
may be permitted?
A stock on which stock option and
single stock future contracts are proposed to be introduced is required to fulfill
the following broad eligibility criteria:-
• The stock shall be chosen from amongst the top 500 stock in terms of average daily
market capitalisation and average daily traded value in the previous six month on
a rolling basis.
• The stock's median quarter-sigma order size over the last six months shall be
not less than Rs.1 Lakh. A stock's quarter-sigma order size is the mean order size
(in value terms) required to cause a change in the stock price equal to one-quarter
of a standard deviation.
• The market wide position limit in the stock shall not be less than Rs.50 crores.
• A stock can be included for derivatives trading as soon as it becomes eligible.
However, if the stock does not fulfill the eligibility criteria for 3 consecutive
months after being admitted to derivatives trading, then derivative contracts on
such a stock would be discontinued.
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9) What is minimum contract size?
The Standing Committee on Finance,
a Parliamentary Committee, at the time of recommending amendment to Securities Contract
(Regulation) Act, 1956 had recommended that the minimum contract size of derivative
contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based
on this recommendation SEBI has specified that the value of a derivative contract
should not be less than Rs. 2 Lakh at the time of introducing the contract in the
market. In February 2004, the Exchanges were advised to re-align the contracts sizes
of existing derivative contracts to Rs. 2 Lakhs. Subsequently, the Exchanges were
authorized to align the contracts sizes as and when required in line with the methodology
prescribed by SEBI.
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10) What is the lot size of a contract?
Lot size refers to number of underlying
securities in one contract. The lot size is determined keeping in mind the minimum
contract size requirement at the time of introduction of derivative contracts on
a particular underlying. For example, if shares of XYZ Ltd are quoted at Rs.1000
each and the minimum contract size is Rs.2 lacs, then the lot size for that particular
scrips stands to be 200000/1000 = 200 shares i.e. one contract in XYZ Ltd. covers
200 shares.
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11) What is corporate adjustment?
The basis for any adjustment for
corporate action is such that the value of the position of the market participant
on cum and ex-date for corporate action continues to remain the same as far as possible.
This will facilitate in retaining the relative status of positions viz. in-the-money,
at-the-money and out-of-the-money. Any adjustment for corporate actions is carried
out on the last day on which a security is traded on a cum basis in the underlying
cash market. Adjustments mean modifications to positions and/or contract specifications
as listed below:
• Strike price
• Position
• Market/Lot/ Multiplier
The adjustments are carried out on any or all of the above based on the nature of
the corporate action. The adjustments for corporate action are carried out on all
open, exercised as well as assigned positions. The corporate actions are broadly
classified under stock benefits and cash benefits. The various stock benefits declared
by the issuer of capital are:
• Bonus
• Rights
• Merger/ demerger
• Amalgamation
• Splits
• Consolidations
• Hive-off
• Warrants, and
• Secured Premium Notes (SPNs) among others
The cash benefit declared by the issuer of capital is cash dividend.
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12) What is the margining system in the derivative markets?
Two type of margins have been specified
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Initial Margin - Based on 99% VaR and worst case loss over a specified horizon,
which depends on the time in which Mark to Market margin is collected.
Mark to Market Margin (MTM) - collected in cash for all Futures contracts
and adjusted against the available Liquid Networth for option positions. In the
case of Futures Contracts MTM may be considered as Mark to Market Settlement.
Dr. L.C Gupta Committee had recommended that the level of initial margin required
on a position should be related to the risk of loss on the position. The concept
of value-at-risk should be used in calculating required level of initial margins.
The initial margins should be large enough to cover the one day loss that can be
encountered on the position on 99% of the days. The recommendations of the Dr. L.C
Gupta Committee have been a guiding principle for SEBI in prescribing the margin
computation & collection methodology to the Exchanges. With the introduction of
various derivative products in the Indian securities Markets, the margin computation
methodology, especially for initial margin, has been modified to address the specific
risk characteristics of the product. The margining methodology specified is consistent
with the margining system used in developed financial & commodity derivative markets
worldwide. The exchanges were given the freedom to either develop their own margin
computation system or adapt the systems available internationally to the requirements
of SEBI. A portfolio based margining approach which takes an integrated view of
the risk involved in the portfolio of each individual client comprising of his positions
in all Derivative Contracts i.e. Index Futures, Index Option, Stock Options and
Single Stock Futures, has been prescribed. The initial margin requirements are required
to be based on the worst case loss of a portfolio of an individual client to cover
99% VaR over a specified time horizon.
The Initial Margin is Higher of (Worst Scenario Loss +Calendar Spread Charges) Or
Short Option Minimum Charge
The worst scenario loss are required to be computed for a portfolio of a client
and is calculated by valuing the portfolio under 16 scenarios of probable changes
in the value and the volatility of the Index/ Individual Stocks. The options and
futures positions in a client's portfolio are required to be valued by predicting
the price and the volatility of the underlying over a specified horizon so that
99% of times the price and volatility so predicted does not exceed the maximum and
minimum price or volatility scenario. In this manner initial margin of 99% VaR is
achieved. The specified horizon is dependent on the time of collection of mark to
market margin by the exchange. The probable change in the price of the underlying
over the specified horizon i.e. 'price scan range', in the case of Index futures
and Index option contracts are based on three standard deviation (3s ) where 's
' is the volatility estimate of the Index. The volatility estimate 's ', is computed
as per the Exponentially Weighted Moving Average methodology. This methodology has
been prescribed by SEBI. In case of option and futures on individual stocks the
price scan range is based on three and a half standard deviation (3.5 s) where 's'
is the daily volatility estimate of individual stock. If the mean value (taking
order book snapshots for past six months) of the impact cost, for an order size
of Rs. 0.5 million, exceeds 1%, the price scan range would be scaled up by square
root three times to cover the close out risk. This means that stocks with impact
cost greater than 1% would now have a price scan range of - Sqrt (3) * 3.5s or approx.
6.06s. For stocks with impact cost of 1% or less, the price scan range would remain
at 3.5s.
For Index Futures and Stock futures it is specified that a minimum margin of 5%
and 7.5% would be charged. This means if for stock futures the 3.5 s value falls
below 7.5% then a minimum of 7.5% should be charged. This could be achieved by adjusting
the price scan range.
The probable change in the volatility of the underlying i.e. 'volatility scan range'
is fixed at 4% for Index options and is fixed at 10% for options on Individual stocks.
The volatility scan range is applicable only for option products.
Calendar spreads are offsetting positions in two contracts in the same underlying
across different expiry. In a portfolio based margining approach all calendar-spread
positions automatically get a margin offset. However, risk arising due to difference
in cost of carry or the 'basis risk' needs to be addressed. It is therefore specified
that a calendar spread charge would be added to the worst scenario loss for arriving
at the initial margin. For computing calendar spread charge, the system first identifies
spread positions and then the spread charge which is 0.5% per month on the far leg
of the spread with a minimum of 1% and maximum of 3%. Further, in the last three
days of the expiry of the near leg of spread, both the legs of the calendar spread
would be treated as separate individual positions. In a portfolio of futures and
options, the non-linear nature of options make short option positions most risky.
Especially, short deep out of the money options, which are highly susceptible to,
changes in prices of the underlying. Therefore a short option minimum charge has
been specified. The short option minimum charge is 3% and 7.5 % of the notional
value of all short Index option and stock option contracts respectively. The short
option minimum charge is the initial margin if the sum of the worst -scenario loss
and calendar spread charge is lower than the short option minimum charge. To calculate
volatility estimates the exchange are required to uses the methodology specified
in the Prof J.R Varma Committee Report on Risk Containment Measures for Index Futures.
Further, to calculate the option value the exchanges can use standard option pricing
models - Black-Scholes, Binomial, Merton, Adesi-Whaley.
The initial margin is required to be computed on a real time basis and has two components:-
The first is creation of risk arrays taking prices at discreet times taking latest
prices and volatility estimates at the discreet times, which have been specified.
The second is the application of the risk arrays on the actual portfolio positions
to compute the portfolio values and the initial margin on a real time basis.
The initial margin so computed is deducted from the available Liquid Networth on
a real time basis. At the end of the day NSE sends a client wise file to all the
brokers and this margin is debited to clients. Next day the broker is supposed to
report the collection of margin. If the margin is short, a penalty is levied and
the outstanding position is liable to be squared up at the cost of the investor.
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13) What are Market wide position limits for single stock futures and
stock option Contracts?
Market wide position limits on
Single Stock Derivative Contracts are as follows
The market wide limit of open position (in terms of the number of underlying stock)
on futures and option contracts on a particular underlying stock is lower of-
- 30 times the average number of shares traded daily, during the previous calendar
month, in the relevant underlying security in the underlying segment,
Or
- 20% of the number of shares held by non-promoters in the relevant underlying security
i.e. free-float holding.
This limit would be applicable on all open positions in all futures and option contracts
on a particular underlying stock.
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14) What measures have been specified by SEBI to protect the rights of
investor in Derivatives Market?
The measures specified by SEBI
include:
• Investor's money has to be kept separate at all levels and is permitted to be
used only against the liability of the Investor and is not available to the trading
member or clearing member or even any other investor.
• The Trading Member is required to provide every investor with a risk disclosure
document which will disclose the risks associated with the derivatives trading so
that investors can take a conscious decision to trade in derivatives.
• Investor would get the contract note duly time stamped for receipt of the order
and execution of the order. The order will be executed with the identity of the
client and without client ID order will not be accepted by the system. The investor
could also demand the trade confirmation slip with his ID in support of the contract
note. This will protect him from the risk of price favour, if any, extended by the
Member.
• In the derivative markets all money paid by the Investor towards margins on all
open positions is kept in trust with the Clearing House/Clearing corporation and
in the event of default of the Trading or Clearing Member the amounts paid by the
client towards margins are segregated and not utilised towards the default of the
member. However, in the event of a default of a member, losses suffered by the Investor,
if any, on settled / closed out position are compensated from the Investor Protection
Fund, as per the rules, bye-laws and regulations of the derivative segment of the
exchanges.
• In the derivative markets all money paid by the Investor towards margins on all
open positions is kept in trust with the Clearing House/Clearing corporation and
in the event of default of the Trading or Clearing Member the amounts paid by the
client towards margins are segregated and not utilised towards the default of the
member. However, in the event of a default of a member, losses suffered by the Investor,
if any, on settled / closed out position are compensated from the Investor Protection
Fund, as per the rules, bye-laws and regulations of the derivative segment of the
exchanges.
• The Exchanges are required to set up arbitration and investor grievances redressal
mechanism operative from all the four areas / regions of the country.
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Remember, Derivatives are tools which can be used for hedging, speculation as well
as trading. It is always advisable to take positions in derivatives with caution.
Since the trader is required to give only margin, there is a tendency of overtrading
which must be avoided. Overtrading may result in failure to pay margin call &/or
MTM the outstanding position is liable to be squared up. Before trading it is necessary
that the investor should go through the risk disclosure document carefully so that
he is aware of the precautions to be taken in derivatives trading
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