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 What is a mutual fund?

Let's explain this term in a very simple way. Let's assume that you as an investor have no idea of shares
and stocks. You need professional help and expertise. All you have to do is invest in a mutual fund

A mutual fund scheme collects money from investors and buys and sell stocks collectively.

 Mutual Funds In India

ICICI Prudential Mutual Fund

Birla Mutual Fund

Reliance Mutual Fund Axis Mutual Fund

HDFC Mutual Fund SBI Mutual Fund Sundaram Mutual Fund

IDFC Mutual Fund Tata Mutual Fund UTI Mutual Fund L&T mutual fund

Franklin Templeton Mutual Fund

Kotak Mutual Fund

Principal Mutual Fund

Quantum Mutual Fund

DSP Blackrock Mutual Fund

IDBI Mutual Fund BNP Paribas Mutual Fund

Canara Robeco Mutual Fund

HSBC Mutual Fund

Baroda Pioneer Mutual Fund

Taurus Mutual Fund

Motilal Oswal Mutual Fund

BOI AXA Mutual Fund

Escorts Mutual Fund Mutual Fund

 Process on Mutual Fund

Let's give you an example Say, there is a Mutual Fund Scheme called Super Returns Mutual Fund,
launched by Super Returns Asset Management Company.

When it gathers say Rs 100 crores, it invests the money gathered from several investors into the stock
markets. If the scheme is an equity scheme it would invest most of its money in shares, while if it was a
debt scheme it would invest the same in debt like government securities, bonds etc.

Now, the fund will offer you units at Rs 10 initially. You buy one unit at Rs 10. Say, you buy 1000 units at
Rs 10 and you pay a sum of Rs 10,000. One year down the line the stocks invested by the Super Return
Mid Cap Fund rise and net asset value climbs to Rs 12. You can now sell the units back to the mutual
fund at Rs 12 and you would get Rs 12,000 for your 1000 units. What happens for a new buyer who is
interested to buy the units? For a new buyer who is interested to buy the units he would have to buy the
units at Rs 12, since the net asset value has climbed. This means he has to pay Rs 12.

 Types of mutual funds in India

1. Equity Funds; Equity funds invest most of the money that they gather from investors into equity
shares. These are high risk schemes and investors can also make losses, since most of the money is
parked into shares. These types of schemes are suitable for investors with an appetite for risk.
2. Debt Funds; Debt funds invest most of their money into debt schemes including corporate debt,
debt issued by banks, gilts and government securities. These types of funds are suitable for investors
who are not willing to take risks. Returns are almost assured in these types of schemes.
3. Balanced funds; Balanced funds invest their money in equity as well as debt. They generally tend to
skew the money more into equity than debt. The objective in the end is again to earn superior
returns. Of course, they might alter their investment pattern based on market conditions.
4. Money Market Mutual Funds; Money market mutual funds are also called Liquid funds. They invest
a bulk of their money in safer short-term instruments like Certificates of Deposit, Treasury and
Commercial Paper. Most of the investment is for a smaller duration.
5. Gilt Funds; Gilt Funds are perhaps the most secure instruments that are around. They invest bulk of
their money in government securities. Since they have backing of the government they are
considered the safest mutual fund units around. Check More Article on Gilt Funds.
How to Apply for Mutual Funds?

If you are an investor who is looking at the much talked about mutual fund SIPs, there are many
ways to apply to them. Many brokers accept mutual fund applications. Apart from this you can also
apply directly through the website. Many mutual funds will give you login and password after you
register. Remember, you need to comply with Know Your Customer Requirements before you apply.
This is also known as KYC Requirement of Mutual Funds. You can also call the various toll free
numbers of mutual funds, which can provide you all guidance on how to invest. Understanding the
Mutual Fund Schemes Remember, you need to understand the MF schemes before you invest. In
the above para, we have made aware of how the various schemes operate. What is most important
is that investors pick and choose carefully. If you are a person who has retired, it would be
dangerous to choose the equity option. You would do well to consider debt mutual funds. Similarly,
if you are young and have a steady income flow, opt for SIPs through equity mutual funds.


A mutual fund is a trust that pools the savings of a number of investors who share a common
financial goal. The money thus collected is invested in capital market instruments such as shares,
debentures, and other securities. The income earned through these investments is shared by its
unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most
suitable investment for the common man as it offers an opportunity to invest in a diversified,
professionally managed basket of securities at a relatively low cost.

Investments in securities are spread across a wide cross section of industries and sectors and
thereby reduce the risk. Asset Management Companies (AMCs) normally come out with a
number of schemes with different investment objectives from time to time. A mutual fund is
required to be registered with the Securities and Exchange Board of India (SEBI), which
regulates securities markets before it can collect funds from the public.


Prof K Geert Rouwenhorst in 'The Origins of Mutual Funds', states that the origin of pooled
investing concept dates back to the late 1700s in Europe, when "a Dutch merchant and broker
invited subscriptions from investors to form a trust to provide an opportunity to diversify for
small investors with limited means." The emergence of "investment pooling" in England in the
1800s brought the concept closer to the US shores.

The enactment of two British laws, the Joint Stock Companies Acts of 1862 and 1867, permitted
investors to share in the profits of an investment enterprise and limited investor liability to the
amount of investment capital devoted to the enterprise. Shortly thereafter, in 1868, the Foreign
and Colonial Government Trust was formed in London.

It resembled the US fund model in basic structure, providing "the investor of moderate means the
same advantages as the large capitalists by spreading the investment over a number of different
stocks." More importantly, the British fund model established a direct link with the US securities
markets, helping finance the development of the post-Civil War US economy.

The Scottish American Investment Trust, formed in February 1873, by fund pioneer Robert
Fleming, invested in the economic potential of the US, chiefly through American railroad bonds.
Many other trusts followed them, who not only targeted investment in America, but led to the
introduction of the fund investing concept on the US shores in the late 1800s and the early 1900s.
The first mutual or 'open-ended' fund was introduced in Boston in March 1924. The
Massachusetts Investors Trust, which was formed as a common law trust, introduced important
innovations to the investment company concept by establishing a simplified capital structure,
continuous offering of shares, and the ability to redeem shares rather than holding them until
dissolution of the fund and a set of clear investment restrictions as well as policies.

The stock market crash of 1929 and the Great Depression that followed greatly hampered the
growth of pooled investments until a succession of landmark securities laws, beginning with the
Securities Act, 1933 and concluded with the Investment Company Act, 1940, reinvigorated
investor confidence. Renewed investor confidence and many innovations led to relatively steady
growth in industry assets and number of accounts.


The mutual fund industry in India started in 1963 with the formation of Unit Trust of India (UTI)
at the initiative of the Reserve Bank of India (RBI) and the Government of India. The objective
then was to attract small investors and introduce them to market investments. Since then, the
history of mutual funds in India can be broadly divided into six distinct phases.

Phase I (1964-87): Growth Of UTI:

In 1963, UTI was established by an Act of Parliament. As it was the only entity offering mutual
funds in India, it had a monopoly. Operationally, UTI was set up by the Reserve Bank of India
(RBI), but was later delinked from the RBI. The first scheme, and for long one of the largest
launched by UTI, was Unit Scheme 1964.

Later in the 1970s and 80s, UTI started innovating and offering different schemes to suit the
needs of different classes of investors. Unit Linked Insurance Plan (ULIP) was launched in 1971.
The first Indian offshore fund, India Fund was launched in August 1986. In absolute terms, the
investible funds corpus of UTI was about Rs 600 crores in 1984. By 1987-88, the assets under
management (AUM) of UTI had grown 10 times to Rs 6,700 crores.

Phase II (1987-93): Entry of Public Sector Funds:

The year 1987 marked the entry of other public sector mutual funds. With the opening up of the
economy, many public sector banks and institutions were allowed to establish mutual funds. The
State Bank of India established the first non-UTI Mutual Fund, SBI Mutual Fund in November
1987. This was followed by Canbank Mutual Fund,LIC Mutual Fund, Indian Bank Mutual Fund,
Bank of India Mutual Fund, GIC Mutual Fund and PNB Mutual Fund. From 1987-88 to 1992-
93, the AUM increased from Rs 6,700 crores to Rs 47,004 crores, nearly seven times. During this
period, investors showed a marked interest in mutual funds, allocating a larger part of their
savings to investments in the funds.

Phase III (1993-96): Emergence of Private Funds:

A new era in the mutual fund industry began in 1993 with the permission granted for the entry of
private sector funds. This gave the Indian investors a broader choice of 'fund families' and
increasing competition to the existing public sector funds. Quite significantly foreign fund
management companies were also allowed to operate mutual funds, most of them coming into
India through their joint ventures with Indian promoters.
The private funds have brought in with them latest product innovations, investment management
techniques and investor-servicing technologies. During the year 1993-94, five private sector fund
houses launched their schemes followed by six others in 1994-95.

Phase IV (1996-99): Growth And SEBI Regulation:

Since 1996, the mutual fund industry scaled newer heights in terms of mobilization of funds and
number of players. Deregulation and liberalization of the Indian economy had introduced
competition and provided impetus to the growth of the industry.

A comprehensive set of regulations for all mutual funds operating in India was introduced with
SEBI (Mutual Fund) Regulations, 1996. These regulations set uniform standards for all funds.
Erstwhile UTI voluntarily adopted SEBI guidelines for its new schemes. Similarly, the budget of
the Union government in 1999 took a big step in exempting all mutual fund dividends from
income tax in the hands of the investors. During this phase, both SEBI and Association of Mutual
Funds of India (AMFI) launched Investor Awareness Programme aimed at educating the
investors about investing through MFs.

Phase V (1999-2004): Emergence of a Large and Uniform Industry:

The year 1999 marked the beginning of a new phase in the history of the mutual fund industry in
India, a phase of significant growth in terms of both amount mobilized from investors and assets
under management. In February 2003, the UTI Act was repealed. UTI no longer has a special
legal status as a trust established by an act of Parliament. Instead it has adopted the same
structure as any other fund in India - a trust and an AMC.

UTI Mutual Fund is the present name of the erstwhile Unit Trust of India (UTI). While UTI
functioned under a separate law of the Indian Parliament earlier, UTI Mutual Fund is now under
the SEBI's (Mutual Funds) Regulations, 1996 like all other mutual funds in India.
The emergence of a uniform industry with the same structure, operations and regulations make it
easier for distributors and investors to deal with any fund house. Between 1999 and 2005 the size
of the industry has doubled in terms of AUM which have gone from above Rs 68,000 crores to
over Rs 1,50,000 crores.

Phase VI (From 2004 Onwards): Consolidation and Growth:

The industry has lately witnessed a spate of mergers and acquisitions, most recent ones being the
acquisition of schemes of Allianz Mutual Fund by Birla Sun Life, PNB Mutual Fund by
Principal, among others. At the same time, more international players continue to enter India
including Fidelity, one of the largest funds in the world.


Mutual fund investments in stocks, bonds and other instruments require considerable expertise
and constant supervision, to allow an investor to take the right decisions. Small investors usually
do not have the necessary expertise and time to undertake any study that can facilitate informed
decisions. While this is the predominant reason for the popularity of mutual funds, there are
many other benefits that make mutual funds appealing.

Diversification Benefits:

Diversified investment improves the risk return profile of the portfolio. Optimal diversification
has limitations due to low liquidity among small investors. The large corpus of a mutual fund as
compared to individual investments makes optimal diversification possible. Due to the pooling
of capital, individual investors can derive benefits of diversification.

Low Transaction Costs:

Mutual fund transactions are generally very large. These large volumes attract lower brokerage
commissions and other costs as compared to smaller volumes of the transactions that individual
investors enter into. The brokers quote a lower rate of commission due to two reasons. The first
is competition for the institutional investors business. The second reason is that the overhead cost
of executing a trade does not differ much for large and small orders. Hence for a large order
these costs spread over a large volume enabling the broker to quote a lower commission rate.

Availability of Various Schemes:

There are four basic types of mutual funds: equity, bond, hybrid and money market. Equity funds
concentrate their investments in stocks. Similarly bond funds primarily invest in bonds and other
securities. Equity, bond and hybrid funds are called long-term funds. Money market funds are
referred to as short-term funds because they invest in securities that generally mature in about
one year or less. Mutual funds generally offer a number of schemes to suit the requirement of the

Professional Management:

Management of a portfolio involves continuous monitoring of various securities and innumerable

economic variables that may affect a portfolio's performance. This requires a lot of time and
effort on part of the investors along with in-depth knowledge of the functioning of the financial
markets. Mutual funds are managed by fund managers generally with knowledge and experience
whose time is solely devoted to tracking and updating the portfolio. Thus investment in a mutual
fund not only saves time and effort for the investor but is also likely to produce better results.


Liquidating a portfolio is not always easy. There may not be a liquid market for all securities
held. In case only a part of the portfolio is required to be liquidated, it may not be possible to see
all the securities forming a part of the portfolio in the same proportion as they are represented in
the portfolio; investing in mutual funds can solve these problems. A fund house generally stands
ready to buy and sell its units on a regular basis. Thus it is easier to liquidate holdings in a
Mutual Fund as compared to direct investment in securities.


In India dividend received by investors is tax-free. This enhances the yield on mutual funds
marginally as compared to income from other investment options. Also in case of long-term
capital gains, the investor benefits from indexation and lower capital gain tax.


Features of a MF scheme such as regular investment plan, regular withdrawal plans and dividend
reinvestment plan allows investors to systematically invest or withdraw funds according to the
needs and convenience.

Well Regulated:

All mutual funds are registered with SEBI and they function within the provisions of strict
regulations designed to protect the interest of investors. The SEBI regularly monitors the
operations of an AMC.


In India, the mutual fund industry is highly regulated with a view to imparting operational
transparency and protecting the investor's interest. The structure of a mutual fund is determined
by SEBI regulations. These regulations require a fund to be established in the form of a trust
under the Indian Trust Act, 1882. A mutual fund is typically externally managed. It is now an
operating company with employees in the traditional sense.
Instead, a fund relies upon third parties that are either affiliated organizations or independent
contractors to carry out its business activities such as investing in securities. A mutual fund
operates through a four-tier structure. The four parties that are required to be involved are a
sponsor, Board of Trustees, an asset management company and a custodian.

Sponsor: A sponsor is a body corporate who establishes a mutual fund. It may be one person
acting alone or together with another corporate body. Additionally, the sponsor is expected to
contribute at least 40% to the net worth of the AMC. However, if any person holds 40% or more
of the net worth of an AMC, he shall be deemed to be a sponsor and will be required to fulfill the
eligibility criteria specified in the mutual fund regulation.

Board Of Trustees: A mutual fund house must have an independent Board of Trustees, where
two-thirds of the trustees are independent persons who are not associated with the sponsor in any
manner. The Board of Trustees of the trustee company holds the property of the mutual fund in
trust for the benefit of the unit-holders. They are responsible for protecting the unit-holder's

Asset Management Company: The role of an AMC is highly significant in the mutual fund
operation. They are the fund managers i.e. they invest investors' money in various securities
(equity, debt and money market instruments) after proper research of market conditions and the
financial performance of individual companies and specific securities in the effort to meet or beat
average market return and analysis. They also look after the administrative functions of a mutual
fund for which they charge management fee.

Custodian: The mutual fund is required by law to protect their portfolio securities by placing
them with a custodian. Nearly all mutual funds use qualified bank custodians. Only a registered
custodian under the SEBI regulation can act as a custodian to a mutual fund.

Over the years, with the involvement of the RBI and SEBI, the mutual fund industry has evolved
in a big way giving investors an opportunity to make the most of this investment avenue. With a
proper structure in place, the industry has been able to cater to more number of investors. With
the increase in awareness about mutual funds several new players have joined the bandwagon.
What is a 'Mutual Fund'
A mutual fund is an investment vehicle made up of a pool of money collected from many
investors for the purpose of investing in securities such as stocks, bonds, money market
instruments and other assets. Mutual funds are operated by professional money managers, who
allocate the fund's investments and attempt to produce capital gains and/or income for the fund's
investors. A mutual fund's portfolio is structured and maintained to match the investment
objectives stated in its prospectus.


Mutual funds give small or individual investors access to professionally managed portfolios of
equities, bonds and other securities. Each shareholder, therefore, participates proportionally in
the gains or losses of the fund. Mutual funds invest in a wide amount of securities, and
performance is usually tracked as the change in the total market cap of the fund, derived by
aggregating performance of the underlying investments.

Mutual fund units, or shares, can typically be purchased or redeemed as needed at the fund's
current net asset value (NAV) per share, which is sometimes expressed as NAVPS. A fund's NAV
is derived by dividing the total value of the securities in the portfolio by the total amount of
shares outstanding.

How Mutual Fund Companies Work

Mutual funds are virtual companies that buy pools of stocks and/or bonds as recommended by an
investment advisor and fund manager. The fund manager is hired by a board of directors and is
legally obligated to work in the best interest of mutual fund shareholders. Most fund managers
are also owners of the fund, though some are not.

There are very few other employees in a mutual fund company. The investment advisor or fund
manager may employ some analysts to help pick investments or perform market research. A fund
accountant is kept on staff to calculate the fund's net asset value (NAV), or the daily value of the
mutual fund that determines if share prices go up or down. Mutual funds need to have a
compliance officer or two, and probably an attorney, to keep up with government regulations.

Most mutual funds are part of a much larger investment company apparatus; the biggest have
hundreds of separate mutual funds. Some of these fund companies are names familiar to the
general public, such as Fidelity Investments, the Vanguard Group, T. Rowe Price and
Oppenheimer Funds.
Advantages of Mutual Funds
Diversification: Diversification, or the mixing of investments and assets within a portfolio to
reduce risk, is one of the advantages to investing in mutual funds. Buying individual company
stocks in retail and offsetting them with industrial sector stocks, for example, offers some
diversification. But a truly diversified portfolio has securities with different capitalizations and
industries, and bonds with varying maturities and issuers. Buying a mutual fund can achieve
diversification cheaper and faster than through buying individual securities.

Economies of Scale: Mutual funds also provide economies of scale. Buying one spares the
investor of the numerous commission charges needed to create a diversified portfolio. Buying
only one security at a time leads to large transaction fees, which will eat up a good chunk of the
investment. Also, the $100 to $200 an individual investor might be able to afford is usually not
enough to buy a round lot of a stock, but it will buy many mutual fund shares. The smaller
denominations of mutual funds allow investors to take advantage of dollar cost averaging.

Easy Access: Trading on the major stock exchanges, mutual funds can be bought and sold with
relative ease, making them highly liquid investments. And, when it comes to certain types of
assets, like foreign equities or exotic commodities, mutual funds are often the most feasible way
– in fact, sometimes the only way – for individual investors to participate.

Professional Management: Most private, non-institutional money managers deal only with high
net worth individuals – people with six figures (at least) to invest. But mutual funds are run by
managers, who spend their days researching securities and devising investment strategies. So
these funds provide a low-cost way for individual investors to experience (and hopefully benefit
from) professional money management.

Individual-Oriented: All these factors make mutual funds an attractive options for younger,
novice and other individual investors who don't want to actively manage their money: They offer
high liquidity; they are relatively easy to understand; good diversification even if you do not
have a lot of money to spread around; and the potential for good growth. In fact, many
Americans already invest in mutual funds through their 401(k) or 403(b) plans. In fact, the
overwhelming majority of money in employer-sponsored retirement plans goes into mutual

Style: Investors have the freedom to research and select from managers with a variety of styles
and management goals. For instance, a fund manager may focus on value investing, growth
investing, developed markets, emerging markets, income or macroeconomic investing, among
many other styles. One manager may also oversee funds that employ several different styles.

Disadvantages of Mutual Funds

Fluctuating Returns: Like many other investments without a guaranteed return, there is always
the possibility that the value of your mutual fund will depreciate. Equity mutual funds experience
price fluctuations, along with the stocks that make up the fund. The Federal Deposit Insurance
Corporation (FDIC) does not back up mutual fund investments, and there is no guarantee of
performance with any fund. Of course, almost every investment carries risk. But it's especially
important for investors in money market funds to know that, unlike their bank counterparts, these
will not be insured by the FDIC.

Cash: As you know already, mutual funds pool money from thousands of investors, so every day
people are putting money into the fund as well as withdrawing it. To maintain the capacity to
accommodate withdrawals, funds typically have to keep a large portion of their portfolios in
cash. Having ample cash is great for liquidity, but money sitting around as cash is not working
for you and thus is not very advantageous.

Costs: Mutual funds provide investors with professional management, but it comes at a cost –
those expense ratios mentioned earlier. These fees reduce the fund's overall payout, and they're
assessed to mutual fund investors regardless of the performance of the fund. As you can imagine,
in years when the fund doesn't make money, these fees only magnify losses.

Diworsification: Many mutual fund investors tend to overcomplicate matters – that is, they
acquire too many funds that are highly related and, as a result, don't get the risk-reducing benefits
of diversification; in fact, they have made their portfolio more exposed, a syndrome called
diworsification. At the other extreme, just because you own mutual funds doesn't mean you are
automatically diversified. For example, a fund that invests only in a particular industry sector or
region is still relatively risky.

Lack of Transparency: One thing that can lead to diworsification is the fact that a fund's
purpose or makeup isn't always clear. Fund advertisements can guide investors down the wrong
path. The Securities and Exchange Commission (SEC) requires that funds have at least 80% of
assets in the particular type of investment implied in their names; how the remaining assets are
invested is up to the fund manager. However, the different categories that qualify for the required
80% of the assets may be vague and wide-ranging. A fund can therefore manipulate prospective
investors via its title: A fund that focuses narrowly on Congo stocks, for example, could be sold
with the grander title "International High-Tech Fund."

Evaluating Funds: Researching and comparing funds can be difficult. Unlike stocks, mutual
funds do not offer investors the opportunity to compare the P/E ratio, sales growth, earnings per
share, etc. A mutual fund's net asset value gives investors the total value of the fund's portfolio,
less liabilities, but how do you know if one fund is better than another?
Who is a Registrar and Transfer agent?
It is binding for the respective Mutual Fund house to maintain a record of all such transactions.
This is because it would become a burden for a Mutual Fund house to take care of all these
transactions on its own. Due to lack of skilled manpower or time constraints, it may outsource
work related to these transactions to an external agency. These agencies can directly handle these
requests made by investors. This job is performed by people who are also known as Registrar
and Transfer agents.

Responsibility of a Registrar and Transfer agent

It is the sole responsibility of an R & T agent to maintain the records of all such transactions
carried by them on behalf of the fund house, through various branches of offices set up in various
parts of the country. These agencies act as a single-window system for investors. This provides
investors with a simplified method to receive forms of their fund houses. This also helps
complete their transactions, and even receive a record of their account statements.

Registrar and Transfer agents also offer investors with all details related to new fund offers,
maturity dates of fixed maturity plans or even the date and amount pertaining to dividend
distributions. While fund houses can also provide such information, an R & T agent is a one-stop
contact for all your investor needs on various schemes and investments.

Benefits of dealing with a Registrar and Transfer agent

While being of great value to an investor, R & T agents are a blessing in disguise to Mutual Fund
houses as well. This is because they provide better accessibility at lower costs to them.

It is important that you get complete knowledge about your R& T advisor to ensure that he is a
genuine agent. It would be completely absurd if you are forced to take a loan of some kind
because you lost all your investments due to a dubious investment agent.

So, ensure that you get all the background details about the agent right before you proceed with
your investment decisions. Apart from that, ask yourself if you actually need an R&T agent or

Do you have multiple investments that need to be carried on with a Registrar and Transfer agent?
Are you seeking to make investments in multiple schemes? Well, you can do so with the help of
an R & T agent. It’s a lot easier than scrambling to connect with different fund houses for deals
and information on investments. These R & T agents will help them make investments and
conduct all related transactions for them.
It is the responsibility of a Mutual Fund house to bear the costs incurred by an R & T agent,
which depends on the volume of transactions carried out by the agent for the Mutual Fund house.
This amount is then directed by the Mutual Fund house through the charge of the expense ratio.

As an investor, you are not required to make any independent payments for your services to the
agent. Do not forget to read the terms and conditions though. This will help you get a complete
understanding as to how your policy functions and the charges associated with it.

If you’re looking to invest, go ahead and explore your options.

Know your rights and duties as an MF investor

Every mutual fund investor enjoys certain rights under Sebi’s laws and rules and fund houses are bound
to extend those rights to their investors. Some fund houses, which are investor focused, however, extend
services which are more than what their regulatory obligations. Here are some of those rights that
mutual fund investors currently enjoy.

Scheme related documents

As a potential investor in a mutual fund scheme, you are allowed to go through all the details about the
scheme that you intend to invest in. You have the right to get a set of documents which include scheme
information document (SID) and statement of additional information (SAI). These two together forms the
offer document for the scheme you intend to invest in. The fund house should also provide you key
information document (KIM), a set of documents containing some important information about the
scheme and also the fund house. In case there are any changes to the scheme you have invested in, the
fund house should inform you about such changes.

Distributor commission/fees

You could invest in a mutual fund scheme directly or through an authorized distributor. In case the your
investment is through a mutual fund distributor, you have the right to know the fees, commissions etc
that the fund house is paying to the distributor who is getting you to invest in the scheme. Rules also
allow you to know how much the distributor makes through fees, commissions etc if he/she sells a
competing scheme to you. This information can give you some idea if the distributor is pushing you a
scheme that will give him/her a higher remuneration than a competing product. If you find that the your
distributor is getting the highest commission by selling the scheme in which you intend to invest, in that
case you should probe a little more about the suitability of the scheme that you intend to invest in.You
also have a right to seek professional help, from a financial planner or advisor, in such situations. After
you have invested in a scheme through a distributor, he/she should keep you updated, on a regular basis,
about the scheme,market conditions, the investing climate etc.which could make the investing
experience better.
Scheme related updates

You should get an SMS/email alert from your fund house within five working days after each investment,
even SIPs. You can also get a monthly update for all the transactions done during that particular month
from Association of Mutual Funds in India (AMFI), the fund industry trade body. Named consolidated
account statement (CAS), this file would contain the details of all transactions, across all schemes from
across all the fund houses through which you have invested. For CAS, income tax PAN is the sole
identifier. You can register your email ID to get eCAS. Even if you don’t transact every month, every six
months you will get a CAS with all the details of your mutual fund holdings. As an investor, you should
also receive annual reports from all the fund houses you have your investments.

Redemption, dividends etc.

We invest to reap the benefits when we need the money. So redemption is as important as investment.
When you redeem your investments, you should receive your redemption proceeds within 10 working
days. If the proceeds are sent after 10 days, you have a right to receive interest at the rate of 15% per
annum for the period of delay after the expiry of the 10th working day. The same rule also applies in
case of dividend payments from fund houses, but here the duration is of 30 calendar days. You are
entitled to receive interest for any delay in payment of dividend after the expiry of the 30-day period.

Dividend statement

At times investors may require a summary of dividends received during a financial year. Some fund
houses provide mail back services to investors, detailing dividends paid in a portfolio. In case dividend
and redemption is not received by an investor, some fund houses provide trackers on their website
which help investors to know the status of such payouts.

Missed call and SMS services

Some fund houses give the facility to investors where they could give a missed call to a dedicated
number and get the full details of their portfolio with that fund house. Some fund houses also allow
investors to transact through SMS.

Complaint redressal system

Every fund house has a complaint redressal mechanism to address investor grievances. If you have any
complaints, you can approach the designated officer in the fund house. If that is not redressed to your
satisfaction, you can approach AMFI, or even Sebi, the regulator.

Keep KYC updated, prepare a will

As the link between investors and mutual fund houses and companies which sell other financial
products, financial planners and advisors play a very important role. They are the first point of contact
who make investors aware of their rights and duties. Often along with fund houses, they conduct
financial literacy seminars for existing as well as prospective investors to make them aware of various
issues related to investing, which also include the rights of an investor and also the duties of an investor
so that the experience of investing remains smooth hassle free.

“One of the first things that we insist for all our clients is that they should go for the ‘Anyone or survivor’
option for accounts and also opt for nomination,” said Nirav Panchmatia, founder-CEO, AUM Financial
Advisors. Such a process ensures that the transition of wealth and investments are smooth in case the
main person who is investing incapable to carry of the transaction for any reason.

Updated information in every investors Know Your Customer (KYC) log is also very important. For the last
couple of years, Sebi has made KYC compliance much easier and once a KYC data is uploaded with one
KYC registration agency, the same is valid for all transactions across all investments regulated by Sebi.
Any change in KYC data is also replicated with other KRAs within a few days. “We ensure that all the KYC-
related information like name is correctly entered, contact address, mobile number and other
information are up to date,” said Panchmatia.

Financial planners and advisors also help investors keep away from schemes which are not registered
with Sebi. Often investors fall prey to ponzy schemes. So make them aware of such schemes and tell
them that they should not invest through cash, the investments should be in cheque and should be in
the name of an entity registered with Sebi, Panchmatia said.

Financial planners and advisors also tell their clients that they have the right to ask about the fees and
commissions that the planners and adivors receive by selling a product to them. This is a Sebi mandate
and once this thing is settled, usually the process of advisor investor relationship is smooth, Panchmatia

Financial planners and advisors also make their clients aware of how they need to be regular and
disciplined in their approach to investing. “We do not encourage short term trading for our clients,” said
Rajiv Bose, a Kolkata-based financial advisor. “For our clients, who want to invest in equities, the
investment horizon is 5-7 years. And we also insist that they should be regular and disciplined in their
approach to investing,” Bose said.

Another very important aspect to good investing is making a Will, said Panchmatia. “Often it is seen that
the investments that the main member in the family had made is completely unknown to the other
members in the same family. Having a Will helps solve that kind of problems,”Panchmatia said.
Why should investors invest in regulated mutual fund schemes?

Lure of assured high returns in a short period of time often attracts investors to schemes floated by
unregulated entities. However, there is a serious lack of transparency in such schemes in terms of
information and regulatory adherence.

Market regulator Securities and Exchange Board of India (Sebi) spells out some of the most important
advantages of investing in a scheme which is regulated:

> Investors’ money is managed by regulated entities

> Mutual funds permit small investment amounts, giving retail investors the advantage of professional
fund management

> Entire money is invested in accordance with the fund’s investment objective, while in most of the
unregulated schemes, the agent takes away a substantial part of the investment as commission

> Commission and other expenses are charged within the permitted expense limits

> The portfolio usually has high liquidity and asset diversification, an important attribute for financial

> Money is used to buy assets as per investment objective of the scheme and the portfolio is then
disclosed to the investors on a monthly basis on mutual funds websites

> Mutual funds follow a three-tier structure: Sponsor, Trustee, Asset Management Company which
ensures a system of checks and balances

> MFs are under independent trustees and have custodians for their assets, thus ensuring that the assets
are ring-fenced from unauthorized use

> Change in viability position of the AMC does not per se impact the interest of mutual fund unit holders,
as the assets of every mutual fund is separately held in a Trust

> There is proof of flow of investors’ money

> Value of mutual fund scheme units (Net Asset Value) is computed on daily basis (marked to market)

> Offer documents provide details of the scheme assisting to understand risk involved, enabling investors
to take informed investment decisions
> Norms exist to ensure that redemption amount/dividend is paid back to investors within a stipulated
timelines, and if not, amount has to be returned along with interest

> To make asset managers responsible, they are also required to invest certain amount of their own
money in the scheme

> Mis-selling of mutual fund schemes is a punishable offence

Determine Your Investment Objectives and Understanding Your Risk Profile

Like any purchase decision, your selection of a mutual fund scheme should be based on your
expectations and the funds’ ability to fulfill these goals. It is important to be clear about your investment
objective before you enter into a buying decision.

If you are planning to build a mutual fund portfolio, the first step is to examine your current situation.
Ask yourself questions like:

1. Why am I investing in a mutual fund?

2. What kind of returns do I expect?

3. What portion of my net worth would I like to set aside for investments?

4. What do I intend to use the gains for? How many years do I have?

5. What is my investment objective?

a. Capital Appreciation
b. Capital Preservation
c. Achieving sustainable long term growth
d. Combination of Income and Capital growth

6. What kind of risk am I willing to take in the long run?

Be Clear About Your Investment Objectives

Investment objectives can be broadly classified into:

1. Generating an additional source of income

2. Financing future needs
a. Buying a home
b. Building a retirement corpus
c. Child’s education and marriage
d. Legacy Planning

3. Increasing savings/ Inducing savings

4. Reducing tax liability

5. Protecting your savings from inflation

Evaluate Your Risk Appetite

To fulfill any investment objective, investors should first evaluate their risk appetite. While some
investors are satisfied by investing in a low-risk : low-return scheme, others are willing to endure short-
term loss for long-term potential gains.

A risk profile offers you suggestions about the investment options that best suit your needs and lifestyle.

Factors That Determine Your Risk Appetite

1. Current Scenario – Your age, financial dependents, assets and liabilities, sources of income, level of
engagement (active or passive investor) and investible capital

2. Past Experience – Knowledge about investment products, inclination to learn, nature and composition
of the last held portfolio and its performance

3. Future Outlook – Time horizon available to fulfill the investment objectives, liquidity requirements in
the near future, importance of tax savings vis-à-vis return on investment

4. Investment Attitude – Willingness towards risk taking, ability to withstand short-term notional losses
in return for long-term high returns

Based on your responses, an experienced MF advisor can determine your risk appetite and classify you
as a conservative, assertive or an aggressive investor (there could be as many as five to seven investor
classifications suggesting different debt-equity allocations).

Mutual Fund Types Based on Risk Profile

Your risk appetite is an important factor while choosing the mutual funds scheme/s that fits your goals of
growth, stability and timeframe.

1. A conservative investor’s primary objective is to preserve the capital and receive regular income. They
have a low tolerance for risk and hence a major chunk of their investment should be allocated to debt or
money market mutual funds like income schemes, FMPs, etc.

2. A moderately aggressive investor is the one who is willing to take controlled risk for moderate
returns. Such investors are generally recommended a mix of balanced, income, and index schemes so
that they can benefit from a balanced portfolio.

3. Aggressive investors consider risk as an opportunity and leverage their experience and knowledge to
take intelligent financial decisions. The major share of their investment, therefore, goes to growth and
equity schemes.

For most investment schemes, risk and returns are directly proportional. It is important to create the
right balance between the two based on your objectives and risk appetite.
Why Should You Invest in Mutual Funds?

considering investment opportunities, the first challenge that almost every investor faces is a plethora of
options. From stocks, bonds, shares, money market securities, to the right combination of two or more
of these, however, every option presents its own set of challenges and benefits.

So why should investors consider mutual funds over others to achieve their investment goals?

Mutual funds allow investors to pool in their money for a diversified selection of securities, managed by
a professional fund manager. It offers an array of innovative products like fund of funds, exchange-traded
funds, Fixed Maturity Plans, Sectoral Funds and many more.

Whether the objective is financial gains or convenience,mutual funds offer many benefits to its investors.

Beat Inflation

Mutual Funds help investors generate better inflation-adjusted returns, without spending a lot of time
and energy on it.While most people consider letting their savings ‘grow’ in a bank, they don’t consider
that inflation may be nibbling away its value.

Suppose you have Rs. 100 as savings in your bank today. These can buy about 10 bottles of water. Your
bank offers 5% interest per annum, so by next year you will have Rs. 105 in your bank.

However, inflation that year rose by 10%. Therefore, one bottle of water costs Rs. 11. By the end of the
year, with Rs. 105, you will not be able to afford 10 bottles of water anymore.
Mutual Funds provide an ideal investment option to place your savings for a long-term inflation adjusted
growth, so that the purchasing power of your hard earned money does not plummet over the years.

Expert Managers

Backed by a dedicated research team, investors are provided with the services of an experienced fund
manager who handles the financial decisions based on the performance and prospects available in the
market to achieve the objectives of the mutual fund scheme.


Mutual funds are an ideal investment option when you are looking at convenience and timesaving
opportunity. With low investment amount alternatives, the ability to buy or sell them on any business
day and a multitude of choices based on an individual’s goal and investment need, investors are free to
pursue their course of life while their investments earn for them.

Low Cost

Probably the biggest advantage for any investor is the low cost of investment that mutual funds offer, as
compared to investing directly in capital markets. Most stock options require significant capital, which
may not be possible for young investors who are just starting out.
Mutual funds, on the other hand, are relatively less expensive. The benefit of scale in brokerage and fees
translates to lower costs for investors. One can start with as low as Rs. 500 and get the advantage of long
term equity investment.


Going by the adage, ‘Do not put all your eggs in one basket’, mutual funds help mitigate risks to a large
extent by distributing your investment across a diverse range of assets. Mutual funds offer a great
investment opportunity to investors who have a limited investment capital.


Investors have the advantage of getting their money back promptly, in case of open-ended schemes
based on the Net Asset Value (NAV) at that time. In case your investment is close-ended, it can be traded
in the stock exchange, as offered by some schemes.

Higher Return Potential

Based on medium or long-term investment, mutual funds have the potential to generate a higher return,
as you can invest on a diverse range of sectors and industries.

Safety &Transparency

Fund managers provide regular information about the current value of the investment, along with their
strategy and outlook, to give a clear picture of how your investments are doing.

Moreover, since every mutual fund is regulated by SEBI, you can be assured that your investments are
managed in a disciplined and regulated manner and are in safe hands.

Every form of investment involves risk. However, skilful management, selection of fundamentally sound
securities and diversification can help reduce the risk, while increasing the chances of higher returns
over time.

Different Types and Kinds of Mutual Funds

The mutual fund industry of India is continuously evolving. Along the way, several industry bodies are
also investing towards investor education. Yet, according to a report by Boston Analytics, less than 10%
of our households consider mutual funds as an investment avenue. It is still considered as a high-risk
In fact, a basic inquiry about the types of mutual funds reveals that these are perhaps one of the most
flexible, comprehensive and hassle free modes of investments that can accommodate various types of
investor needs.
Various types of mutual funds categories are designed to allow investors to choose a scheme based on
the risk they are willing to take, the investable amount, their goals, the investment term, etc.

Let us have a look at some important

mutual fund schemes under the following three categories based on maturity period of investment:

I. Open-Ended – This scheme allows investors to buy or sell units at any point in time. This does not have
a fixed maturity date.

1. Debt/ Income - In a debt/income scheme, a major part of the investable fund are channelized towards
debentures, government securities, and other debt instruments. Although capital appreciation is low
(compared to the equity mutual funds), this is a relatively low risk-low return investment avenue which is
ideal for investors seeing a steady income.

2. Money Market/ Liquid – This is ideal for investors looking to utilize their surplus funds in short term
instruments while awaiting better options. These schemes invest in short-term debt instruments and
seek to provide reasonable returns for the investors.

3. Equity/ Growth – Equities are a popular mutual fund category amongst retail investors. Although it
could be a high-risk investment in the short term, investors can expect capital appreciation in the long
run. If you are at your prime earning stage and looking for long-term benefits, growth schemes could be
an ideal investment.

3.i. Index Scheme – Index schemes is a widely popular concept in the west. These follow a passive
investment strategy where your investments replicate the movements of benchmark indices like Nifty,
Sensex, etc.

3.ii. Sectoral Scheme – Sectoral funds are invested in a specific sector like infrastructure, IT,
pharmaceuticals, etc. or segments of the capital market like large caps, mid caps, etc. This scheme
provides a relatively high risk-high return opportunity within the equity space.

3.iii. Tax Saving – As the name suggests, this scheme offers tax benefits to its investors. The funds are
invested in equities thereby offering long-term growth opportunities. Tax saving mutual funds (called
Equity Linked Savings Schemes) has a 3-year lock-in period.

4. Balanced – This scheme allows investors to enjoy growth and income at regular intervals. Funds are
invested in both equities and fixed income securities; the proportion is pre-determined and disclosed in
the scheme related offer document. These are ideal for the cautiously aggressive investors.

II. Closed-Ended – In India, this type of scheme has a stipulated maturity period and investors can invest
only during the initial launch period known as the NFO (New Fund Offer) period.

1. Capital Protection – The primary objective of this scheme is to safeguard the principal amount while
trying to deliver reasonable returns. These invest in high-quality fixed income securities with marginal
exposure to equities and mature along with the maturity period of the scheme.

2. Fixed Maturity Plans (FMPs) – FMPs, as the name suggests, are mutual fund schemes with a defined
maturity period. These schemes normally comprise of debt instruments which mature in line with the
maturity of the scheme, thereby earning through the interest component (also called coupons) of the
securities in the portfolio. FMPs are normally passively managed, i.e. there is no active trading of debt
instruments in the portfolio. The expenses which are charged to the scheme, are hence, generally lower
than actively managed schemes.

III. Interval – Operating as a combination of open and closed ended schemes, it allows investors to trade
units at pre-defined intervals.

Which scheme should I invest in?

When it comes to selecting a scheme to invest in, one should look for customized advice. Your best bet
are the schemes that provide the right combination of growth, stability and income, keeping your risk
appetite in mind.
Concept and Evolution of Mutual Funds in India

As the name suggests, a ‘mutual fund’ is an investment vehicle that allows several investors to pool their
resources in order to purchase stocks, bonds and other securities.

These collective funds (referred to as Assets Under

Management or AUM) are then invested by an expert fund manager appointed by a mutual fund
company (called Asset Management Company or AMC).

The combined underlying holding of the fund is known as the ‘portfolio’, and each investor owns a
portion of this portfolio in the form of units.


The mutual fund industry in India began in 1963 with the formation of the Unit Trust of India (UTI) as an
initiative of the Government of India and the Reserve Bank of India. Much later, in 1987, SBI Mutual
Fund became the first non-UTI mutual fund in India.

Subsequently, the year 1993 heralded a new era in the mutual fund industry. This was marked by the
entry of private companies in the sector. After the Securities and Exchange Board of India (SEBI) Act was
passed in 1992, the SEBI Mutual Fund Regulations came into being in 1996. Since then, the Mutual fund
companies have continued to grow exponentially with foreign institutions setting shop in India, through
joint ventures and acquisitions.
As the industry expanded, a non-profit organization, the Association of Mutual Funds in India (AMFI),
was established on 1995. Its objective is to promote healthy and ethical marketing practices in the Indian
mutual fund Industry. SEBI has made AMFI certification mandatory for all those engaged in selling or
marketing mutual fund products.

Why should one invest in a mutual fund?

1. MFs are managed by professional fund managers, responsible for making wise investments according
to market movements and trend analysis.

2. MFs allow you to invest your savings across a variety of securities and diversify your assets according
to your objectives, and risk tolerance.

3. MFs provide investors the freedom to earn on their personal savings. Investments can be as less as Rs.

4. MFs offer relatively high liquidity.

5. Certain mutual fund investments are tax efficient. For example, domestic equity mutual funds
investors do not need to pay capital gains tax if they remain invested for a period of above 1 year.
What are the different types of mutual funds?

Each mutual fund scheme has its own objective that determines its assets allocation and investment

These are classified according to their maturity period, or investment objective. One can also classify
mutual funds as ‘open ended funds’ - where investors may invest or redeem at any point in time and
‘close ended funds’ - where investors can invest only during the initial launch period known as the NFO
(New Fund Offer) period.

Mutual funds classified according to their investment objective range from Equity Funds (with
substantial risk), to Money Market Funds (which are very safe). Other types include debt schemes, index
funds, balanced funds, etc.

How does one earn returns in a mutual funds?

After investing your money in a mutual fund, you can earn returns in two forms:

1. In the form of dividends declared by the scheme

2. Through capital appreciation - meaning an increase in the value of your investments.

7 best equity mutual fund categories for your portfolio

There are several categories of equity mutual funds. As per the risk-taking capacity of an investor, these
mutual funds are segregated into various categories. If one invests wisely over a longer period of time,
then one can achieve one's financial goals very easily.

These funds are designed in a way to provide stability and sustainability throughout the investment

There are several categories of equity mutual funds. As per the risk-taking capacity of an investor, these
mutual funds are segregated into various categories. If one invests wisely over a longer period of time,
then one can achieve one’s financial goals very easily. This will also help one in prioritising one’s savings,
income and making expenses in a proper way.

Here are seven different kinds of equity mutual funds where one can invest one’s money:

Large Cap Funds

Lap cap funds are the funds which comprise of blue-chips companies having large market capitalization.
However, one should know that the criteria of being a large cap varies from company to company, which
basically depends on the huge market capitalization.

There are several types of mutual fund schemes available in the market which can be either bought from
financial services companies or directly through AMCs. These funds are designed in a way to provide
stability and sustainability throughout the investment tenure. The returns are slightly lesser but can
easily beat inflation in the long term. These funds, when linked with a financial goal, can help you in
achieving them in the long term.

Mid-Small Cap Funds

These funds provide exceptionally high returns but they are very risky in nature. These funds comprise of
stocks of small and emerging companies which ideally provide very good returns in future terms.
Generally, as the name suggests, these companies have low market capitalization. If you think that you
are aggressive in taking risks, then you can invest in such kind of funds.

Flexi-cap Funds

These funds are more or less diversified type of funds. As the funds do not dependent on the market
capitalization of a company, the fund manager is able to make the best use of opportunities which they
can get through market volatility. The scope of doing diversification of the investment widens when you
are investing your money in flexi cap funds.

Diversified Funds

One can minimise one’s risk by taking exposure to this investment fund. This fund spreads the risk into
various sectors as the investment fund contains a wide variety of securities. This fund helps the risk-
averse investors to take exposure to a diversified mutual fund scheme. Also, actively managing
diversification helps in preventing the events that affect one sector and may reduce heavy losses if
market conditions willingly go wrong anytime in future during the investment tenure.

Thematic Funds

Unlike sector funds where you can invest your money only in certain sectors, these funds provide a wider
scope of diversification while making investments. Here the fund manager does the selection of
companies from different sectors on the basis of a common theme. For example, the theme can be
infrastructure funds which comprise of sectors like oil corporations, gas, steel, etc.


These funds carry a very minimum lock-in period and provide you a tax benefit of Rs 1.5 lakh under
section 80C of I-T Act. These funds are equity linked which not only provide you the taxation benefit but
also help in boosting your invested amount by generating a good amount of inflation-beaten corpus at
the time of maturity. Mostly, the scheme which falls under this category has a lock-in period of 3 years

Index Fund
An index fund is a fund whose returns are matched with the market index component. These funds are
passive in nature. Index funds generally have low expense ratio because of which they tend to
outperform various other indexes. However, one should know that these funds consist of moderately
high risk.

12 mutual fund terms you must know

As you probably know, a mutual fund is an investment that pools together money from a number
of investors. It then uses professionals to manage and invest this money with the aim of
achieving a return.

The mutual funds industry is regulated by the Securities and Exchange Board of India.

If you are interested in investing in mutual funds, here are some terms you need to understand.


An Asset Management Company is the fund house or the company that manages the money.

The mutual fund is a trust registered under the Indian Trust Act. It is initiated by a sponsor. A
sponsor is a person who acts alone or with a corporate to establish a mutual fund. The sponsor
then appoints an AMC to manage the investment, marketing, accounting and other functions
pertaining to the fund.

For instance, ABN AMRO Trustee (India) Private Limited is appointed as the trustee to the ABN
AMRO mutual fund.
ABN AMRO Asset Management (India) Limited is appointed as its investment manager.

Various funds with different objectives can be floated under the umbrella of one parent.

So ABN AMRO Equity Fund, ABN AMRO Opportunities Fund and ABN AMRO Flexi Debt
Fund are all independent schemes of ABN AMRO Mutual Fund. They are managed by the ABN


The Net Asset Value is the price of a unit of a fund. When a fund comes out with an NFO, it is
priced Rs 10. Later, depending on the value of the investments, this price could rise or fall.


This is a fee that is charged when you buy or sell the units of a fund.

When you buy the units of a fund, you pay a percentage of it as a fee. This is known as the entry

Let's say you are investing Rs 10,000 and the entry load is 2%. That means you pay Rs 200 as
the entry load and Rs 9,800 is invested in the fund.

Now, let's assume you are selling the units of your fund. And the Rs 10,000 you invested initially
is now Rs 15,000. Let's further assume the exit load is 2%. So you pay Rs 300 and get back Rs
Generally, if funds charge an entry load, they will not charge an exit load. Or vice versa. Only
one of the loads is charged.

The load is a percentage of the NAV.


This is the term given to all the investments made by the fund as well as the amount held in cash.


Let's assume a very small mutual fund has an initial investment of 1,000 units and each unit is
worth Rs 10. Hence, the total amount with the fund is Rs 10,000. This is referred to as the
corpus. Later, some other investors invest Rs 2,000. Now the corpus will be Rs 12,000 (Rs
10,000 + Rs 2,000).

The total amount invested (Rs 12,000) is called the corpus or the total amount of money invested
in the fund.


Assets Under Management is the total value of all the investments currently being managed by
the fund.

Let's say the corpus is Rs 12,000 but, due to a rise in the price of the shares it has invested in, the
value of the units has increased. So the Rs 12,000 invested is now worth Rs 15,000. This figure
is referred to as AUM.
Diversified equity mutual fund

This is a mutual fund that invests in stocks of various companies in various sectors.


Equity Linked Saving Schemes are diversified equity mutual funds with a tax benefit under
Section 80C of the Income Tax Act.

To avail of the tax benefit, your money must be locked up for at least three years.

Balanced fund

A fund that invests in both equity (shares) and debt (fixed return investments) is known as a
balanced fund.

Debt fund

These are funds that invest in fixed return investments like bonds. A liquid fund is one that
invests in money market instruments, these are fixed return investments of a very short tenure.


A New Fund Offering is the term given to a new mutual fund scheme.

A Systematic Investment Plan refers to periodic investing in a mutual fund. Every month or
every three months, the investor will have to commit to putting in a fixed amount. This will go
towards the purchase of units.

Let's say that every month you commit to investing, say, Rs 1,000 in your fund. At the end of a
year, you would have invested Rs 12,000.

If the NAV on the day you invest in the first month is Rs 20, you will get 50 units.

The next month, the NAV is Rs 25. You will get 40 units.

The following month, the NAV is Rs 18. You will get 55.56 units.

So, after three months, you would have 145.56 units. On an average, you would have paid
around Rs 21 per unit. This is because, when the NAV is high, you get fewer units per Rs 1,000.
When the NAV falls, you get more units per Rs 1,000.


What are Exchange Traded Funds (ETFs)?

Exchange Traded Fund (ETF) is in news as the government has decided to use ETF mechanism
to disinvest the shares of public sector companies. The idea is to cumulate the shares of selected
PSUs proposed for disinvestment under a single fund (that forms the base of Exchange Traded
Fund). Then these cumulated shares are divided into different units/shares (as in the case of
mutual funds). The value of one unit (or ETF unit/share) depends upon prices of underlying PSU
shares. These units can be listed in the stock exchange as ETF and can be traded like ordinary
shares. The advantage is that listing and trading in stock exchanges gives tradability (easy for
buying and selling) to the ETF shares. This will attract investor participation in ETFs. Retail and
institutional investors will easily trade this ETF shares as the ETF has high liquidity as in the
case of ordinary shares.

For the government, ETF route will help to avoid the cumbersome exercise of several IPOs
(Initial Public Offerings). Otherwise, each PSU disinvestment necessitates separate listing or
IPOs. Similarly, investor participation will go up.

What are exchanges traded funds?

An ETF is a type of fund that owns the underlying assets and is divided into different shares. It is
a marketable security (in the form of shares) that contains a slice of cumulated
shares/bonds/commodities/foreign currencies that is sliced into different shares. Gold ETF is an
important instrument in the NSE. Following are the main features of ETFs.

 ETFs as funds owns underlying assets like shares of different companies.

 The shares of different companies are pooled together and these cumulated shares form the
asset base of ETFs.

 Then the cumulated assets are divided into different units and these units are listed and traded
in the stock exchange as ETFs.

 These ETFs that are listed in the stock exchanges are considered like shares (of ETFs) and can be
traded like ordinary shares.

 Thus, the ETFs are listed and traded in the stock exchange like shares.

 The ETFs trading value is based on the net asset value of the underlying stocks that it represents.

 In nature, the ETFs are index funds (funds that comprised of shares of different companies –
ETF vs Mutual Funds

Mutual fund is like an ETF as it is a unit that comprised of equities of different companies. But
ETF and mutual funds differ with respect to tradability. Mutual Fund selling price will be the
price of shares at the close of the day. On the other hand, shares of ETF are traded throughout the
day. And at any moment, ETF can be bought and sold. In this respect, ETFs have more liquidity
and marketability. Another difference is that Mutual Fund is managed by a financial company
and its fund managers; whereas the ETF is managed by the investor himself (unless deputed).

ETFs experience price changes throughout the day as they are bought and sold. ETFs typically
have higher daily liquidity and lower fees than mutual fund shares, making them an attractive
alternative for individual investors.

Before deciding to invest using exchange-traded funds, make sure you understand their features
as well as their risks.

ETFs are pooled investments that trade on an exchange throughout the day. They either track a
stock or bond index or execute an active strategy by a fund manager.

Let's consider several features of ETFs.

One is diversification. An index ETF might contain hundreds, even thousands, of securities
providing broad diversification. That can help offset the risks associated with any one security or
market sector.

So if a single stock gains or loses substantial value, the overall effect on the ETF may be rather
small given the price movements of other stocks in the portfolio.

Another feature is low costs. ETFs can be a cost-effective way to invest. ETFs generally have
lower management expense ratios than mutual funds. In Canada, the average MER for ETFs is
about half that of mutual funds.

A third feature is flexibility. Because ETFs can provide broad exposure to different asset
classes or market sectors, they offer a flexible way to build a new portfolio or restructure an
existing one.

A fourth feature is transparency. Most index ETFs hold the same securities—or a
representative sample of them—as their benchmarks. So you tend to know what you're investing

These features come with a flip side:

Their risks.

Consider diversification. Not all ETFs are broadly diversified.

Some are designed to track a specific industry sector or geographic region. If an ETF's
investment objective is narrow, it won't be diversified.

The portfolios of actively managed ETFs can be rather small. Because they're built by a fund
manager who may choose to emphasize specific types of securities, such ETFs may not be
considered broadly diversified either.

As for cost, investing in ETFs involves costs that other investments may not have. For
example, ETFs have trading costs similar to those for stocks. Investors pay those costs whether
they buy units of an ETF or sell them. So investors should always add up the full costs of

Because ETFs can be bought or sold anytime the exchange is open, there are times of the day
when it can be more risky to trade. For example, after the market opens, some of an ETF's
underlying stocks may not be trading yet. That can affect getting an accurate price for the ETF.

ETFs' transparency also comes with a caveat. Because active ETFs don't track an index, you may
not know what's in their portfolios on a daily basis.

Know the risks, know the features.

Diversification, low costs, flexibility and transparency are some of the qualities that have helped
ETFs become a popular choice for investors.

Be sure to understand how ETFs will fit into a portfolio before investing.

The burgeoning popularity of ETFs can be attributed to several of their features that greatly benefit
investors. Here are the top ten, ranked by our assessment of importance to the investor.

Intraday Trading
Since ETFs trade on stock exchanges, investors can buy and sell them during trading hours at
market-determined prices. This feature gives investors instant liquidity and eliminates the need
for them to wait until the end of the day to get filled on their orders, as is the case with mutual
funds. This is of obvious benefit to investors particularly when markets are volatile. For example,
assume the equity market is flat earlier in the day and ends the trading day 1% higher; the
investor who buys an index ETF intraday rather than purchasing a mutual fund (whose price is
determined at the close) would have purchased the ETF at a significantly lower price compared
to the mutual fund.

Low Costs
ETFs typically have lower management fees and expenses than actively managed mutual funds,
and often have lower management fees than index mutual funds. Since ETFs are exchange
traded, the significant costs of record-keeping and the client relationship are handled by the
broker, rather than the mutual fund company that handles these functions for its fund investors.
In addition, ETFs enable investors to acquire a diversified portfolio for a single commission, as
opposed to paying commissions for buying all the underlying securities in the portfolio.

ETFs that track an index will incorporate all – or a representative sample of – the securities that
make up the index, regardless of whether the securities included in the index number in the
hundreds or thousands. This gives an investor a diversified portfolio that may have lower
variability compared to individual securities. It is important to note that merely holding a number
of ETFs does not ensure appropriate diversification, unless one also incorporates prudent asset
allocation. For example, an investor who only holds equity ETFs may be adequately diversified
as far as equities are concerned, but will still be fully exposed to market risk.

There are two aspects of transparency as it pertains to ETFs – portfolio and price. Since index
ETFs hold the same securities as the indexes that they track, investors know precisely what they
are invested in. Even ETFs that do not track indexes publish their full portfolios on a daily basis,
providing ongoing portfolio transparency. In contrast, actively managed mutual funds publish
their portfolios only after a lengthy time lag, as transparency is actually likely to be detrimental
to their business prospects (since investors can invest in the funds’ holdings on their own rather
than through the mutual fund). In addition, ETFs track the market price of their underlying
securities closely; if the price of an ETF deviates significantly from the underlying securities in
its portfolios, arbitrageurs will step in and close the price gap rapidly. This price transparency
ensures that the market price of ETFs is generally very close to its Net Asset Value (NAV),
unlike a closed-end fund, for example, which can trade at a substantial premium or discount to its
NAV. (Related: Advantages And Disadvantages Of ETFs)

Trading Flexibility
Since ETFs trade on an exchange, investors can buy and sell them like regular stocks, using
different types of orders such as limit orders or stop orders to get optimal pricing for their trades.
In contrast, mutual fund investors cannot use similar orders when they trade fund shares, and
there is no scope for price improvement since all fund investors get the same closing NAV price
on a given day. ETFs can also be sold short, just like a stock, and many ETFs have options on
them, providing more trading flexibility to investors.

Access to Niche Markets and Asset Classes

The wide range of ETFs available makes it easy for retail investors to invest in markets and asset
classes that were previously difficult to access, such as small emerging markets, currencies,
commodities and alternative investments. The availability of inverse ETFs and leveraged ETFs
also provides retail investors with more choices for hedging and speculation. Note that many of
these ETFs carry the same risks as their underlying securities, and investors should be fully
conversant with these risks before investing in them.

Increased Choices for Portfolio Construction

The plethora of investment themes and strategies that are available through ETFs gives investors
increased choices for portfolio construction. Apart from the obvious benefit of using ETFs to
create fully diversified portfolios, investors can use ETFs for relatively advanced strategies such
as constructing market-neutral portfolios, hedging risk exposure or creating a net-short position
to capitalize on a market downturn. ETFs enable such portfolios to be created in a very cost-
effective and efficient manner.

Potential Tax Efficiency

ETFs have potentially greater tax efficiency than mutual funds due to their lower portfolio
turnover, and also because they can do in-kind redemptions. As most ETFs track the performance
of a specific benchmark or index, they generally have lower portfolio turnover than actively
managed mutual funds, which translates into fewer capital gains or losses realized that may flow
through to the ETF holders. ETFs also use in-kind redemptions to reduce unrealized gains, which
keeps capital gains and losses low compared to mutual funds; many ETF investors therefore do
not incur taxes on capital gains until they sell their ETF units.

Low Investment Threshold

ETFs make it possible for investors to construct diversified portfolios with a low investment
threshold, a feature that is likely to appeal to young investors who may have limited capital to
invest. This makes it possible to put one’s money to work as soon as possible, rather than waiting
to amass a particular amount before investing.

Elimination of Manager Risk

Actively managed mutual funds usually have a significant degree of manager risk. A top-
performing fund that has consistently outperformed its benchmark likely has a great fund
manager. But what if the manager leaves the fund, or makes a series of poor calls that imperil the
fund’s performance? Such manager risk is virtually eliminated in an ETF, as its objective is to
track an index and not outperform it

How do ETFs work?

You've probably heard exchange-traded funds (ETFs) described as a basket of securities that can be
bought and sold like stocks. But have you ever wondered about the mechanics that enable ETFs' trading

Richard Powers"There are two key concepts to understanding what makes an ETF work: first, creation
and redemption, the process by which ETFs are bundled; and second, the role of authorized participants
(APs), the parties that transact in that process," said Richard Powers, the head of ETF product
management in Vanguard Portfolio Review Department. "The resulting price convergence between an
ETF and its respective basket of securities is what facilitates intraday trading of ETFs."

What is an ETF?

Very simply, an ETF is a wrapper, a vehicle that contains not only a basket of securities, but also a
philosophy and process to invest stock or bond holdings. From this perspective, ETFs and mutual funds
are the same.

For example, whether you purchase an S&P 500 index fund through a mutual fund or an ETF, you're
investing in the same underlying securities. Both investment vehicles will hold all (or most) of the 500
stocks in the same proportion as the index the funds seek to mirror.

How are ETFs and mutual funds different?

The most important difference between ETFs and mutual funds is how you buy and sell them. In other
words, they are more similar than different.
"The "E" and "T" in ETF stand for exchange-traded. That is, ETFs can be bought and sold throughout the
day, the same way stocks are traded on a market exchange. While the "F" stands for fund, as in mutual
fund," Powers explained.

This intraday liquidity offers flexibility and greater control over when and at what price you can trade
ETFs. In contrast, mutual funds trade once a day, at the end of day.

Balance supply and demand with creation and redemption

The creation and redemption mechanism and the role of APs are two key concepts that enable ETFs'
intraday liquidity. Creation and redemption is the process by which ETFs are packaged and

Authorized participants, typically large institutional investors, create and redeem the baskets of
securities. These market makers play an integral role in supplying liquidity and keeping ETF prices
aligned with the market value of the underlying assets throughout the trading day.

When rising demand causes ETF prices to rise higher than the value of the ETF holdings (i.e., trade at a
premium), the role of APs is to buy the underlying securities, exchange them for ETF shares, and then sell
those shares into the market. Conversely, if falling demand causes ETF prices to trade too low (i.e., at a
discount), an AP may buy shares of the ETF in the market and redeem them in exchange for the
underlying securities.

"When the value of the underlying securities increases, so should the value of the pooled security,
whether a mutual fund or an ETF. These arbitrage activities among authorized participants help keep ETF
prices aligned with the market value of the basket of securities," said Powers.

Look under the hood

ETFs offer an attractive and efficient way for investors to implement an investment strategy. So do
mutual funds. The broad diversification and low-cost feature of ETFs are characteristics that can be tied
to their index-based structure. So before you decide on an ETF or a mutual fund, focus your research on
investment objectives and your need for trading flexibility. Because whether you decide to go with an
ETF or mutual fund invested in the same strategy, chances are you'll find the same securities when you
look under the hood.
Authorized Participant
DEFINITION of 'Authorized Participant'
Authorized participants (AP) are one of the major parties at the center of the creation and redemption
process for exchange-traded funds (ETF). They provide a large portion of liquidity in the ETF market by
obtaining the underlying assets required to create a fund. When there is a shortage of shares in the
market, the authorized participant creates more. Conversely, the authorized participant will reduce
shares in circulation when supply falls short or demand. This can be done with the creation and
redemption mechanism that keeps share prices aligned with its underlying net asset value (NAV).

BREAKING DOWN 'Authorized Participant'

Authorized participants are responsible for acquiring the securities that the ETF wants to hold. If that is
the S&P 500 index, they will purchase all its constituents in the same weight and deliver them to the
sponsor. In return, authorized participants receive a block of equally valued shares called a creation unit.
Issuers can use the services of one or more authorized participants for a fund. Large and active funds
tend to have a greater number of authorized participants. This also differs between various types of
funds. Equities, on average, have more participants than bonds perhaps due to greater trading volume.

Traditionally, authorized participants are large banks like Bank of America (BAC), JPMorgan Chase (JPM),
Goldman Sachs (GS), and Morgan Stanley (MS), among others. They do not receive compensation from a
sponsor and have no legal obligation to redeem or create the ETF's shares. Instead, authorized
participants are compensated through activity in the secondary market or service fees collected from
clients yearning to execute primary trades.

In the end, both parties benefit from working together. The sponsor receives help in creating the fund
while the participant gets a block of shares to resell for a profit. This process also works in reverse.
Authorized participants receive the same value of the underlying security in the fund after selling

Competition between Authorized Participants

Multiple authorized participants help improve the liquidity of a particular ETF. The threat of
competition tends to keep the fund trading close to its fair value. More importantly, additional
authorized participants encourage a better functioning market. When one party ceases to act as an
authorized participant, other ones will see the product as a profitable opportunity and offer the
creation/redemption technology. At the same time, the impacted authorized participant has the
option to address any internal issues and resume primary market activities.
What is an 'ETF Sponsor '
An ETF sponsor is the fund manager or financial company that creates and administers an
exchange-traded fund.

An ETF sponsor designs the base index that will assist management of the ETF. A group of institutional
investors supplies the securities that will make up the fund, and in exchange for this delivery, gain so-
called creation units, which are ETF shares in giant blocks, numbering 100,000 or more shares.

Definition of authorised participant

Authorised participants are essential to building exchange traded funds since they create and
redeem the ETF shares, usually in exchange for baskets of the underlying securities, from the
ETF sponsor.

APs typically sign on to support ETFs because they believe they can profit by “arbitraging”
small differences between the price of the fund’s shares and the underlying securities being

"If the ETF price trades above the NAV [net asset value, or the value of the ETF’s securities], the
APs buy the underlying assets in the market and convert them into ETF shares,” JPMorgan
analysts wrote in a note on the topic. “On the other hand, if the ETF price trades at a discount
relative to the NAV, the APs buy ETF shares in the market and redeem them for the underlying

Authorised participants are essential to building the funds since they create and redeem the ETF
shares, usually in exchange for baskets of the underlying securities, from the ETF sponsor.

APs typically sign on to support ETFs because they believe they can profit by “arbitraging”
small differences between the price of the fund’s shares and the underlying securities being
This is a list of notable Indian Exchange Traded funds, or
 Reliance Gold Exchange Traded Scheme (NSE: GOLDBEES)
 Reliance ETF Liquid BeES (formerly Goldman Sachs Liquid Exchange Traded Scheme) Dividend
Reinvestment (NSE: LIQUIDBEES)

 Reliance Nifty Exchange Traded Scheme (NSE: NIFTYBEES)

 Reliance Nifty Junior Exchange Traded Scheme (NSE: JUNIORBEES)

 Reliance Nifty Sharia Exchange Traded Scheme(NSE: SHARIABEES)

 HDFC Mutual Fund - HDFC Gold Exchange Traded Fund (NSE: HDFCMFGETF)

 ICICI Prudential Mutual Fund - Bharat-22 Index Exchange Traded Fund (NSE: BHARATIWIN)

 Invesco India Nifty Exchange Traded Fund (NSE: IVZINNIFTY)

 Invesco India Gold Exchange Traded Fund (NSE: IVZINGOLD)

 Kotak Mutual Fund - Gold Exchange Traded Fund (NSE: KOTAKGOLD)

 Kotak Mutual Fund - PSU Bank Exchange Traded Fund (NSE: KOTAKPSUBK)

 Kotak Mutual Fund - Banking Exchange Traded Fund Dividend Payout Option (NSE: KOTAKBKETF)

 Kotak Mutual Fund - Nifty Index Exchange Traded Fund (NSE: KOTAKNIFTY)

 Kotak Mutual Fund - Sensex Index Exchange Traded Fund (BSE: KOTAKSENSEX)

 Kotak Mutual Fund - Nifty NV20 Index Exchange Traded Fund(NSE: KOTAKNV20)

 Motilal Oswal Mutual Fund - Motilal Oswal MOSt Shares M50 ETF (NSE: M50)

 Motilal Oswal Mutual Fund - Motilal Oswal MOSt Shares M100 ETF (NSE: M100)

 Motilal Oswal Mutual Fund - Motilal Oswal MOSt Shares Nasdaq Index N100 ETF (NSE: N100)

 Reliance Shares Gold ETF (NSE: RELGOLD)

 SBI Mutual Fund - SBI Gold Exchange Traded Scheme - Growth Option (NSE: SBIGETS)

 UTI Mutual Fund (Unit Trust of India Mutual Fund) - UTI Gold Exchange Traded Fund

 UTI Mutual Fund (Unit Trust of India Mutual Fund) - UTI Nifty Next 50 Exchange Traded

How to Buy and Sell an ETF

By Elizabeth Leary, Contributing Editor
July 2, 2010

One big advantage of ETFs is that you can buy and sell them throughout the day, just as you can
stocks. But that may also be a deterrent to investing in ETFs, particularly if you have never
bought or sold a stock. It's really quite simple, though.

First, you need to open a brokerage account. Once you decide which ETF you want to buy, go
to the section of the brokerage firm's Web site for trading stocks and ETFs. Insert the symbol (or
get it from the Web site) and the number of shares you want to buy. From that point, you are
offered a number of choices.

Do you want to submit a market order? With a market order, your purchase (or sale) is filled at
the next available price. Market orders usually go through promptly.

Do you want to submit a limit order? With a limit order, you instruct the broker to buy a stock
only if you can get it at or below the price you set or sell it at or above the limit price. It's
possible that your limit order may not be executed if the stock doesn't hit the price you've
specified. You can always reset your limit.


Given the volatility of the stock market nowadays, it's probably wise to employ a stop order
to protect yourself from a big drop in the price of an ETF you own. There are two types of stop

With a stop-loss order, your trade automatically becomes a market order once the designated
stop price is hit. You may or may not get that price. And if the market is in free fall, as it was on
May 6, you might sell for far less than the stop-loss price.

You may be better off using a stop-limit order in light of the potential danger of getting an
unexpectedly low price. With this technique, your order goes live once the ETF hits your
designated price. But the sale goes through only if you can get the limit price.

You can add other terms to your trades. For example, if you specify a day order and the trade
does not go through that day, it is automatically canceled. Or your order can be good 'til
canceled. When you're ready, press the execute button and start watching for an order report.

The Balance

Types of Exchange Traded Funds (ETFs)

Types of Exchange Traded Funds (ETFs)
Because exchange traded funds continue to gain popularity with every closing bell, it’s
entirely possible the investment community will have too many kinds of ETFs to track.
However, that is not entirely a bad thing. If you look at the overall ETF market, you can
safely categorize the majority of these investment funds into the most popular types of
ETFs. This list will help understand which of these excellent funds makes the most sense
for your overall investment strategy.

 01

United States Market Index ETFs

Market ETFs usually track a major market index and are some of the most active ETFs
on an exchange floor. However, there are some market ETFs that track low-volume
indexes as well. Keep in mind the goal of a market ETF is to emulate an underlying
index, not outperform it. An example would be the QQQQ’s which tracks the Nasdaq-100

 02

Foreign Market Index ETFs

The U.S. is not the only country to have market index ETFs. There are many foreign
ETFs to choose from as well. If you’re an investor looking for international exposure or
to hedge against foreign investment risk then country or region ETFs may be a good
option. Two examples are EWJ, which tracks Japan’s Nikkei Index, and EWG which
tracks the MSCI Germany Index.

 03

Foreign Currency ETFs

Foreign currency ETFs are funds that help investors gain exposure to foreign currencies
without having to complete complex transactions. Currency ETFs are seemingly simple
investment vehicles that track a foreign currency, similar to how a market ETF tracks its
underlying index. In some cases, this type of ETF tracks a basket of currencies, allowing
an investor access to more than one foreign currency.

 04

Sector and Industry ETFs

Industry ETFs are types of ETFs that generally track a sector index representing a certain
industry. They are perfect for gaining exposure to a certain market sector like
pharmaceuticals without having to purchase the plethora of individual companies.
Instead, it only takes one transaction to buy a fund like the PowerShares Dynamic
Pharmaceuticals ETF (PJP) and instantly implement your ETF investing strategy.

 05

Commodity ETFs

Commodity ETFs are similar to industry ETFs in that they are targeted to a certain area
of the market. However, when you purchase a commodity ETF, like gold or energy, you
do not actually buy the commodity, the ETF consists of derivative contracts in order to
emulate the price of the underlying commodity. Therefore, when you buy an oil ETF, you
are actually investing in oil without setting up a mining drill in your backyard.

 06

Derivative ETFs

There are some types of ETFs that do not consist of equities. It's very common with
commodity ETFs that some funds are made up of derivative contracts like futures,
forwards and options. While the goal is to emulate an investment product, there are
different ways to accomplish this within the construction of ETFs. Assets in the fund can
either be individual companies or, in these cases, derivative products.

 07

Style ETFs
Some types of ETFs track a certain investment style or market capitalization (large-cap,
small-cap, mid-cap). Style ETFs are most actively traded in the United States and exist on
growth and value indexes developed by S&P/BARRA and Russell. So, if you have a
certain investment goal based on a market-cap style, you may be able to reach your target
with a style ETF like the SPDR Dow Jones Large Cap Value ETF (ELV) which tracks the
Dow Jones U.S. Large Cap Value Index.

 08

Bond ETFs

The many available bond ETFs runs the gamut, from international to government to
corporate, to name a few. Bond ETFs have a difficult task when it comes to construction
because they track a low-liquidity investment product. Bonds are not active on secondary
markets because normally they are held to maturity. However, ETFs are actively traded
products on exchange floors. ETF providers, like Barclays, have done their job with debt-
based ETFs and have created some successful bond funds like the SPDR Capital Long
Credit Bond ETF (LWC). this offering gives investors opportunities in the bond market
while still maintaining the benefits of ETFs.

 09

ETNs — Exchange Traded Notes

Exchange-traded notes are the little brothers of ETFs. While they are not truly a type of
ETF, because they are more of their own investment, people still lump them into the
major ETF categories.

ETNs are issued by a major bank as senior debt notes. This is different from an ETF
which consists of securities or derivative contracts. When you buy an ETN, you receive a
debt investment similar to a bond. ETNs are backed by high credit rating banks so they
are considered secure investment products. However, the notes are not totally absent of
credit risk.

 10

Inverse ETFs
When the market starts to plummet, investors want to get short. However, trading account
constraints can make that an issue. Margins may not allow for that possibility if someone
is selling a naked investment or if there is a restriction on certain accounts against selling
certain investments. Enter inverse ETFs, funds created to create a short position when
you buy the ETF. They have an inverse reaction to the direction of the underlying index
or asset.

 11

Leveraged ETFs

Leveraged ETFs are a very controversial fund and are better suited for the advanced ETF
trading strategy. A common misconception is that they will produce exponential annual
returns when in fact they are constructed with the goal of creating a leveraged daily
return on underlying indexes and assets. Even then, it is a goal, not an absolute.
Therefore, before you add leveraged ETFs to your portfolio, conduct thorough research.

 12

Actively Managed ETFs

In the ongoing war between ETFs vs. Mutual Funds, there just may be a compromise, the
Actively Managed ETFs. These combine all the benefits of both mutual and exchange-
traded funds in one asset and eliminate some of the disadvantages.

 13

Dividend ETFs

Some ETFs target equities that pay dividends. Usually, dividend ETFs track a dividend
index and the assets in the fund and index consists of a diverse range of dividend-paying
stocks. But in some cases, the dividend stocks are segmented by market-caps or
geographic locations.

 14

Innovative ETFs
Because ETFs are gaining popularity on a daily basis, there are more and more
innovations when it comes to these investment products. Some of the newer and more
innovative funds include ETFs of ETFs, Volatility ETFs, and Tax-Deferred ETFs. Of
course, these two are just the tip of the future ETF iceberg.

These ETF categories outline the majority of the different types of ETFs in the investing
world. As this world continues to grow, so will the different variations. The good news is
that if you are ready to get started with ETFs, you’ll have a lot of different ones to buy or

What is the difference between exchange-

traded funds and mutual funds?
Exchange-traded funds, or ETFs, are similar to mutual funds because both instruments bundle
together securities to offer investors diversified portfolios. Typically anywhere from 100 to 3,000
different securities can make up a fund. Yet, the two investment types are marked by significant

The Differences
ETFs trade throughout the trading day, like stocks, while mutual funds trade only at the end of
the day at the net asset value (NAV) price. Most ETFs track a particular index and as a result
have lower operating expenses than actively-invested mutual funds. Thus, ETFs may
improve your rate of return on investments. In addition, ETFs have no investment minimums or
sales loads, unlike traditional mutual funds, which often have both. Most indexed mutual funds,
however, will not have sales loads.

Taxes and Rate of Return

ETFs create and redeem shares with in-kind transactions that are not considered sales. Thus,
taxable events are not triggered. Redemptions create tax events in mutual funds, but they do not
create tax events in ETFs. When a forced sale of stock occurs, mutual funds record and distribute
higher levels of capital gains than ETFs.

In addition, ETFs have greater tax efficiency due to a structure that allows them to substantially
decrease or avoid capital gains distributions altogether. This difference can greatly affect the
overall rate of return, even if an ETF and mutual fund both track the identical index.

ETFs Mutual Funds

Trade during trading day Trade at closing NAV

Low operating expenses Operating expenses vary

No investment minimums Most have investment minimums

Tax-efficient Less tax-efficient

No sales loads May have sales load

ETF vs. Mutual Funds

Good investment portfolio?

How about your Credit Score?

Credit Score

Recently, there has been a lot of discussion around exchange-traded funds (ETFs) being one of
the best investment channels. For the uninformed, these funds may seem like mutual funds as
they pool together the money of investors to buy a portfolio of bonds and stocks that are diverse.
So what exactly is the difference between the two?

In fact, there is not much of a difference between ETFs and mutual funds. One of the main
differences between the two is the fact that you can buy a share of ETF through a brokerage, like
stocks, not through a fund management company that sells mutual funds.

Most of the ETFs are managed like index funds, which essentially implies that dedicated
managers do not choose the investments that will be held. Instead, these funds mimic a list of
investments. The choice between a mutual fund and an ETF is based on the convenience of the
buyer. If he/she already has a brokerage account it is very easy and convenient to buy an ETF. If
an investor does not have a brokerage account, it is better to opt for a mutual fund instead.

Mr. Kumar started with an investment of Rs. 5,000. Today, he has achieved most of his life
goals.Invest Now

What is ETF?
ETF or Exchange Traded Fund is an investment fund which is traded on the stock exchange. The
assets held under an ETF are commodities, stocks and bonds. These are traded for an amount
close to the original net asset value of the asset, during a trading day. A bond index or stock
index is tracked by most ETFs. The price of the ETF can vary throughout the day. Generally,
ETFs have lower fees and higher daily liquidity compared to mutual fund shares. ETF can be
used for the following purposes: Hedging, Equitizing Cash and for Arbitrage.

ETF shareholders get a part of the profits, i.e, the dividends paid and interest earned. They may
also get a residual value if there is a liquidation of the fund. ETF shares are usually traded on
public stock exchanges, so these shares can be transferred, bought, or sold easily like the shares
of a stock.

ETF supply is regulated through “creation” and “redemption” processes that involve some
special investors, also referred to as authorised participants (APs). APs are usually renowned
financial institutions such as banks and investment firms that have a great deal of buying power.

The key advantages of ETFs are as follows:

 Investors can sell short or buy on margin. They can also purchase one share, as there are no
minimum investment requirements.
 The commission that is paid to the broker when buying or selling ETFs is the same as that paid
for a regular order.

 It is comparable to a mutual fund that can be bought and sold at a cost that varies throughout
the day. The transactions are carried out in real-time as well.
Authorized Participant
DEFINITION of 'Authorized Participant'
Authorized participants (AP) are one of the major parties at the center of the creation and
redemption process for exchange-traded funds (ETF). They provide a large portion of liquidity in
the ETF market by obtaining the underlying assets required to create a fund. When there is a
shortage of shares in the market, the authorized participant creates more. Conversely, the
authorized participant will reduce shares in circulation when supply falls short or demand. This
can be done with the creation and redemption mechanism that keeps share prices aligned with its
underlying net asset value (NAV).

BREAKING DOWN 'Authorized Participant'

Authorized participants are responsible for acquiring the securities that the ETF wants to hold. If
that is the S&P 500 index, they will purchase all its constituents in the same weight and deliver
them to the sponsor. In return, authorized participants receive a block of equally valued shares
called a creation unit. Issuers can use the services of one or more authorized participants for a
fund. Large and active funds tend to have a greater number of authorized participants. This also
differs between various types of funds. Equities, on average, have more participants than bonds
perhaps due to greater trading volume.

Traditionally, authorized participants are large banks like Bank of America (BAC), JPMorgan
Chase (JPM), Goldman Sachs (GS), and Morgan Stanley (MS), among others. They do not
receive compensation from a sponsor and have no legal obligation to redeem or create the
ETF's shares. Instead, authorized participants are compensated through activity in the secondary
market or service fees collected from clients yearning to execute primary trades.

In the end, both parties benefit from working together. The sponsor receives help in creating the
fund while the participant gets a block of shares to resell for a profit. This process also works in
reverse. Authorized participants receive the same value of the underlying security in the fund
after selling shares.

Competition between Authorized Participants

Multiple authorized participants help improve the liquidity of a particular ETF. The threat of
competition tends to keep the fund trading close to its fair value. More importantly, additional
authorized participants encourage a better functioning market. When one party ceases to act as an
authorized participant, other ones will see the product as a profitable opportunity and offer the
creation/redemption technology. At the same time, the impacted authorized participant has the
option to address any internal issues and resume primary market activities.
What are Mutual Funds?
Mutual Funds are a professionally managed investment funds that trades in diversified holdings.
Funds are pooled from various investors and invested with the assistance of professionals. The
investment portfolio includes bonds, money market instruments, stocks or a combination of all.
The investor owns a share of the mutual fund and reap the same benefits or losses as the other

ETF shareholders get a part of the profits, i.e, the dividends paid and interest earned. They may
also get a residual value if there is a liquidation of the fund. ETF shares are usually traded on
public stock exchanges, so these shares can be transferred, bought, or sold easily like the shares
of a stock.

ETF supply is regulated through “creation” and “redemption” processes that involve some
special investors, also referred to as authorised participants (APs). APs are usually renowned
financial institutions such as banks and investment firms that have a great deal of buying power.

The key advantages of ETFs are as follows:

 Investors can sell short or buy on margin. They can also purchase one share, as there are no
minimum investment requirements.
 The commission that is paid to the broker when buying or selling ETFs is the same as that paid
for a regular order.

 It is comparable to a mutual fund that can be bought and sold at a cost that varies throughout
the day. The transactions are carried out in real-time as well.

What is the difference between an ETF and a Mutual Fund?

Mutual Funds Exchange Traded Fund (ETF)

Mutual Funds are traded at the closing net Exchange Traded Funds are traded during the course of a
asset value. trading day and its value varies during this time.

Mutual Funds have varying operating

ETF has lower operating expenses.

Most Mutual Funds have a minimum expense There is no minimum investment specified for Exchange
specified. Traded Funds.

Mutual Funds have more tax liabilities than ETFs offer tax benefits to the investors due to the manner
ETFs. of its creation and redemption.

Mutual Fund shares can only be purchased

ETF can be bought and sold anytime on the stock
directly from the funds at the NAV price that is
exchange, at the prevailing market price.
fixed during the trading day.

Generally, compared to ETFs, the transaction

There is an additional cost involved while trading ETFs,
costs are zero when mutual fund shares are
which is called the “bid-ask spread”.
bought or sold.

ETF has higher liquidity since it is not connected to its

Mutual Funds have lower liquidity compared
daily trading volume. ETF liquidity is related to the
to Exchange Traded Funds.
liquidity of the stocks included in the index.

Some mutual funds levy a penalty on selling ETF do not have a time limit on selling an asset. The
the share early. Usually, the time limit imposed investor can buy or sell at any point of the trading day at
on selling a share is 90 days from the date of the price available during the time. Therefore, there is no
purchase. minimum holding period specified for the same.

Mutual Funds are index-tracking but is actively Exchange Traded Funds track an index, i.e., it tries to
managed by professionals. Assets are picked in match the price movements and returns indicated in an
such a way that it beats the index and achieves index by assembling a portfolio which is similar to the
higher performance. index constituents.

Who Are Market Makers And What Is Step-

Away Trading?

ETFs operate at two levels of liquidity. There is the liquidity of the ETF itself—the liquidity
that’s quoted in your brokerage account—and the liquidity of what the ETF itself holds.

When you’re trading small numbers of shares, what matters most is the liquidity of the ETF
itself. But as you start to trade 10,000, 50,000 or 100,000 shares at a time, the liquidity of what
the ETF holds becomes more important. This is known as the “underlying liquidity.”
Why Underlying Liquidity Matters

Underlying liquidity matters because often, investors making large trades can get better pricing
in an ETF than they otherwise might think.

Consider an ETF that holds very liquid securities—say, the S&P 500—but that only trades 100
shares a day. If you want to buy 100,000 shares of this ETF, you’d think you’d be out of luck.

But really, it should be no trouble at all. Because authorized participants can always create new
shares of an ETF by buying up the underlying stocks and submitting them to an ETF issuer, an
ETF can be considered as liquid as its underlying holdings.

ETF investors are fortunate in that they can access this ETF liquidity in multiple ways. The
simplest way is to enter a reasonable limit order and hope a market maker fills the order. But
more sophisticated investors and advisors will often partner with an outside firm to help facilitate
those trades.

Here’s how they do it:

Step 1: Custodial Agreements And Prime Brokerage

The first step to trading with the help of a liquidity provider is contacting the party responsible
for the custody of your ETP shares and assets. Typically, this is the party through which you
usually trade ETF shares on an exchange. It's also the party responsible for the settlement of your
securities. You’ll need to first be granted permission from them to “trade away” from its platform
with a liquidity provider or market maker.

Keep in mind that custodians and prime brokers may charge a fee for trading away. It’s essential
to determine the nature of this fee (variable or fixed) before deciding if the potential for trade
execution quality outweighs the all-in costs of trading away.

Step 2: Understanding The Product And Capital Markets Help

Understanding the ETF you’re trading and the liquidity of the securities in the index it tracks is
critical to a successful trade. When you contact a liquidity provider with whom to transact off-
exchange, they will give you a quote based on what they believe to be a fair price for shares of
the ETF … plus a little extra. It’s important to understand the fair value of an ETF, as well as the
liquidity available in its underlying portfolio, so you can get a sense of whether this is a fair
price. Sometimes that information is difficult to access without expensive data feeds. There is,
however, a solution: the ETF issuer’s capital markets desk.

The capital markets desk at an ETF issuer is one of the best resources available to investors.
Most issuers staff a desk whose sole purpose is to help investors enter and exit funds at fair
prices. Among their many services, capital markets desks can run underlying portfolio analytics
and give a clearer picture of the market impact of buying the underlying securities. They can also
refer you to liquidity providers from their own network. Best of all, it’s free; why not give it a

Step 3: Selecting And Working With A Liquidity Provider

Selecting a liquidity provider is more art than science—it takes time, and some experience. It
helps to stay with the trusted names, but also keep on the lookout for new parties that might be
aggressive in their quoting in order to attract new business.

Remember, liquidity providers make their money off the flow (the number of shares you trade).
On some days, they might quote aggressively because they can take on the risk in order to keep
you as a client; on other days, they might quote less aggressively because they’re unwilling to
take on the risk. Keep note of the types of ETFs you trade and with which liquidity provider. It’s
likely you may notice some patterns regarding who offers the best prices for any given market.

Step 4: Post-Trade Analysis

After every execution, always obtain an independent post-trade analysis. It’s great if you’re
satisfied with your off-exchange trade, but you’re not done until you do some price checking. A
post-trade analysis allows you to understand the price at which your trade was executed relative
to other transactions that occurred in the fund at the same time.

Making sure you didn’t overpay or undersell is something that should always be done.
Sometimes liquidity providers offer third-party tools to conduct post-trade analytics. Still, the
more independent the assessment, the better.

Unit 4

Debt Funds
Debt funds are managed by professionals that invest in high rated
fixed income earning investments like State or Central government
bonds, RBI bonds, various corporate deposits, money market
instruments etc. It is an investment pool like mutual fund or
exchange traded fund. People like you and me with an excess
amount of money lying with us and wants to earn better returns
than normal bank FD and do not want to take any risk are usually
investing in such funds. This post digs more into What are debt
funds, their features, advantages and disadvantages.

What are Debt Funds?

Simply put, Debt Fund is just another type of mutual fund. They are
valued at NAV basis which keeps on changing daily

The debt funds mostly invest in fixed income earning investment

while equity mutual fund invests in stock markets. This is the major
difference between debt fund and equity mutual fund. Investment in
debt fund is most safer and less risky.

The returns are taxed when there is a sale of debt fund unlike fixed
deposits wherein interest on investment is taxed every year as per
the slab. It will be long term capital gain when debt funds are sold
after three years but if it is sold within three years of purchase then
it will be short term capital gain

It is to be noted that debt funds are managed by the highly

professional team and that is why one can rest assured that his or
her money is in safe hand.

READ Debt Fund vs Fixed Deposit : Which is better?

Debt funds are highly liquid and tradable and one can get money
back within a day time. Do keep in mind that certain debt funds
charged exit load for withdrawal of amount within stipulated time
Let us look at some of the features of debt fund which make them

 Taxation: One peculiar feature of the debt fund is that mutual

fund companies are not liable to deduct any taxes from the earning.
Tax liability arises only when an investor redeems units. Moreover,
he or she can avail set off gains against any other long term or short
term losses.
 Liquidity: As discussed earlier, debts fund are highly liquid
and one can get redemption amount in its own bank account within
a day time.

 Previously before budget of 2014, if one held debt fund for a

period of more than one year then it would be considered as long
term investment. But now if that one year time period has changed
to three years. So if one held debt fund for more than 36 months
then it is considered as long term investment. And this is taxed at a
flat rate of 20%. For short-term capital gain, it is clubbed under
one’s income for that year and taxed as per slab.

 Exit Load: Exit load is levied if investment in debt funds are

sold within prescribed period generally 12 months from the date of

 Safer options: The most important benefit of the debt fund is
that the investment is not affected by equity market risk. As the
professional invest the pool of investment in highly rated fixed
income instruments. Highly safer investment. The debt fund brings
stability in the investment portfolio. Due to this nature of debt fund,
one can expect Steady returns rather than tumultuous ride in Equity
Mutual Funds. One can get regular interest income by investing in
debt fund.
 Liquidity: It is a highly liquid fund, one can withdraw it any
given time and get the redemption amount in the bank account
within a day. It can be treated as savings account whenever you
want you can put money and whenever you want you can withdraw.

 Better Returns: One can get decent returns than 4% in

normal savings bank account and normal bank fixed deposits.

 Indexation Benefit: One can avail the benefit of indexation

and reduced tax amount on returns.

 Taxation: Unlike FD where every year returns are taxed, in

debt funds when one sale or withdraw the amount then only tax is

 Transaction Cost: The transaction cost in debt fund is low as

compared to the mutual fund.

 Debt fund mostly invests in government securities, money
market instruments, corporate deposits, but there can be case when
such government institution or corporate declare itself as bankrupt
or defaulted in paying interest on such deposits. This makes the
debt fund a bit more riskier than the traditional FD.
 There are so many funds available in the market to chose from
hence it becomes very confusing for a new investor to chose a
suitable fund for him or her.

 Nothing comes free of cost in this world. There is a cost

associated with the fund like selling and marketing cost, fund
manager or professionals salary etc. Hence, there is a cost
associated with the fund which is charged to the investors in the
form of expense ratio.

 Individual investors have no control over day to day activities

of the fund as professionals are managing the funds.

To conclude, debt funds are highly liquid and safer investment

option for those who do not want to take any risk of the stock
market. Those who have the spare amounts and want to earn better
returns than traditional investment options.
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What is 'Interest Rate Risk'

The interest rate risk is the risk that an investment's value will change due to a change in the
absolute level of interest rates, in the spread between two rates, in the shape of the yield curve, or
in any other interest rate relationship. Such changes usually affect securities inversely and can be
reduced by diversifying (investing in fixed-income securities with different durations) or hedging
(such as through an interest rate swap).
BREAKING DOWN 'Interest Rate Risk'
Interest rate risk affects the value of bonds more directly than stocks, and it is a major risk to all
bondholders. As interest rates rise, bond prices fall, and vice versa. The rationale is that as
interest rates increase, the opportunity cost of holding a bond decreases, since investors are able
to realize greater yields by switching to other investments that reflect the higher interest rate. For
example, a 5% bond is worth more if interest rates decrease, since the bondholder receives a
fixed rate of return relative to the market, which is offering a lower rate of return as a result of
the decrease in rates.

Market Interest Rates

Interest rate risk is most relevant to fixed-income securities whereby a potential increase in
market interest rates is a risk to the value of fixed-income securities. When market interest rates
increase, prices on previously issued fixed-income securities as traded in the market decline,
since potential investors are now more inclined to buy new securities that offer higher rates. Only
by having lower selling prices can past securities with lower rates become competitive with
securities issued after market interest rates have turned higher.

For example, if an investor buys a a five-year bond that costs $500 with a 3 percent coupon,
interest rates may rise to 4%. In that case, the investor may have difficulty selling the bond when
others enter the market with more attractive rates. Older bonds look less attractive as newly
issued bonds carry higher coupon rates as well. Further, lower demand may cause lower prices
on the secondary market, and the investor is likely to get less for the bond on the market than
he paid for it.

Price Sensitivity
The value of existing fixed-income securities with different maturities declines by various
degrees when market interest rates rise. This is referred to as price sensitivity, meaning that
prices on securities of certain maturity lengths are more sensitive to increases in market interest
rates, resulting in sharper declines in their security values.

For example, suppose there are two fixed-income securities, one maturing in one year and the
other in 10 years. When market interest rates rise, holders of the one-year security could quickly
reinvest in a higher-rate security after having a lower return for only one year. Holders of the 10-
year security would be stuck with a lower rate for 9 more years, justifying a comparably lower
security value than shorter-term securities to attract willing buyers. The longer a security's
maturity, the more its price declines to a given increase in interest rates.

Maturity Risk Premium

The greater price sensibility of longer-term securities leads to higher interest rate risk for those
securities. To compensate investors for taking on more risk, the expected rates of return on
longer-term securities are normally higher than on shorter-term securities. This extra rate of
return is called maturity risk premium, which is higher with longer years to maturity. Along with
other risk premiums, such as default risk premiums and liquidity risk premiums, maturity risk
premiums help determine rates offered on securities of different maturities beyond varied credit
and liquidity conditions

Understanding Credit Risk

Understanding Credit Risk For Corporate

Jan. 15, 2013 5:43 AM ET


Bondsquawk, CFA

CFA, bonds, REITs


By Nicholas Gliagias and Rom Badilla, CFA

One of the most significant risks for bond investors to consider is credit risk. Credit risk, also
known as default risk, is the risk that a bond issuer will default on their payments of interest and
principal. When a bond issuer defaults on their payments, the holders of the bond may lose most
of their principal. For the most part, bonds issued by the federal government are immune from
default and therefore have no credit risk. However, bonds that are issued by corporations are
much more likely to be defaulted on, since companies can go bankrupt. Therefore, credit risk is a
very important factor to consider when investing in corporate bonds.

Corporate bonds tend to offer higher yields compared to other investments to compensate the
bond investor for the credit risk. Corporations that issue high yield bonds can be small
companies or even large companies that are experiencing a degree of financial distress. As high
yield bonds are generally more risky than investment-grade bonds, investors expect to earn a
higher yield to compensate them for that risk. In order to lessen the impact of the default risk, the
buyers of the bond will demand yields that correspond to the issuer's level of default risk. In
other words, usually when the risk of default for a bond becomes higher, the yield of the bond
will also grow.

A good measure to assess the default risk of a bond is its credit rating. Credit ratings are given
out by rating agencies such as Moody's and Standard & Poor's Corporation. Bonds that are seen
as less likely to default are given higher ratings which are usually accompanied by lower yields,
while bonds that are more likely to default are given lower ratings, usually accompanied by
higher yields. In other words, high-yield corporate bonds can carry a lot of credit risk. High-yield
bonds that are poorly rated may also be called junk bonds.

When a bond issuer defaults on their payments, the bondholder may lose their principal.
However, a bond issuer does not have to default for credit risk to affect investors. If one or more
credit rating agency downgrades a bond issue, or the market has a perception this may happen,
the price of a bond will drop. The rating agencies will change their ratings for many different
reasons including a change in the bond issuer's industry, the financial and competitive standing
of the issuer, and anything that will impact the issuer's ability to meet the financial obligation to
bondholders including their ability to pay off their debt.

Credit ratings

A bond issuer’s ability to pay its debts—that is, make all interest and principal payments in full
and on schedule—is a critical concern for investors. Most corporate bonds are evaluated for
credit quality by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings. (See their
rating systems in the chart below.) Checking a bond’s rating before buying is not only smart but
also simple: Just ask your financial consultant.

Bonds rated BBB or higher by Standard & Poor’s and Fitch Ratings, and Baa or higher by
Moody’s, are widely considered “investment grade.” This means the quality of the securities is
high enough for a prudent investor to purchase them.

Bond Credit Quality Ratings

Rating agencies
Standard & Fitch
Credit Risk Moody’s
Poor’s Ratings
Investment grade
Highest quality Aaa AAA AAA
High quality (very strong) Aa AA AA
Upper medium grade (strong) A A A
Medium grade Baa BBB BBB
Not investment grade
Lower medium grade (somewhat speculative) Ba BB BB
Low grade (speculative) B B B
Poor quality (may default) Caa CCC CCC
Most speculative Ca CC CC
No interest being paid or bankruptcy petition
In default C D D

Some bonds are not rated, but this does not necessarily mean they are unsafe. Before buying such
a security, however, ask your financial consultant for other evidence of its quality.

High-yield bonds

Bonds with a rating of BB (Standard & Poor’s, Fitch Ratings) or Ba (Moody’s) or below are
speculative investments. They are called high-yield, or junk, bonds. Such bonds are issued by
newer or start-up companies, companies that have had financial problems, companies in a
particularly competitive or volatile market and those featuring aggressive financial and business
policies. They pay higher interest rates than investment-grade bonds to compensate for the extra
risk. (However, if they were issued before the company’s financial difficulties, the risk may not
be offset by a higher yield.)

For those who do not mind taking substantial risk, such securities can provide exceptional
returns. For the less adventurous who still want to participate in this market, high-yield bond
mutual funds are a way to spread the risk over many issues.

Event risk

In recent years, the managements of many corporations have tried to boost shareholder value by
undertaking leveraged buyouts, restructurings, mergers and recapitalizations. Such events can
push bond values down, sometimes very suddenly, because they may greatly increase a
company’s debt load. Although some corporations have now established bondholder protections,
these are neither widespread nor foolproof. All bonds are subject to this potential risk. An
individual investor should see if the rating agencies have written commentaries on a company’s
vulnerability to event risk before buying the company's bonds.

All information and opinions contained in this publication were produced by the Securities
Industry and Financial Markets Association from our membership and other sources believed by
the Association to be accurate and reliable. By providing this general information, the Securities
Industry and Financial Markets Association makes neither a recommendation as to the
appropriateness of investing in fixed-income securities nor is it providing any specific
investment advice for any particular investor. Due to rapidly changing market conditions and the
complexity of investment decisions, supplemental information and sources may be required to
make informed investment decisions.

Pricing Debt Instruments

Bond Pricing
By The Securities Institute of America, Inc.


 Chapters 1- 4
 Chapters 5 - 8

 Chapters 9 - 11

1. 2.1 Debt Securities/Bonds

2. 2.2 Types Of Bond Issuance

1. 1. Equity Securities 3. 2.3 Bond Pricing

2. 2. Debt Securities 4. 2.4 Bond Pricing

3. 3. Government Securities 5. 2.5 Bond Yields

4. 4. The Money Market 6. 2.6 Yield To Maturity

7. 2.7 Calculating Yields

8. 2.8 Maturities

Once issued, corporate bonds trade in the secondary market between investors similar to the way
equity securities do. The price of bonds in the secondary market depends on all of the following:
 Rating
 Interest rates

 Term

 Coupon rate

 Type of bond

 Issuer

 Supply & demand

 Other features i.e. Callable, convertible

Corporate bonds are always priced, as a percentage of par, and par value for all bonds is always
$1,000, unless otherwise stated.

Par Value

Par value of a bond is equal to the amount that the investor has loaned to the issuer. The terms
par value, face value and principal amount are synonymous and are always equal to $1,000. The
principal amount is the amount that will be received by the investor at maturity, regardless of the
price the investor paid for the bond. An investor who purchases a bond in the secondary market
for $1,000 is said to have paid par for the bond.


In the secondary market, many different factors affect the price of the bond. It is not at all
unusual for an investor to purchase a bond at a price that is below the bond’s par value. Anytime
an investor buys a bond at a price that is below the par value, they are said to be buying the bond
at a discount.


Often market conditions will cause the price of existing bonds to rise and make it attractive for
the investors to purchase a bond at a price that is greater than its par value. Anytime an investor
buys a bond at a price that exceeds its par value, the investor is said to have paid a premium.

Corporate Bond Pricing

All corporate bonds are priced as a percentage of par into fractions of a percent. For example, a
quote for a corporate bond reading 95 actually translates into:

95% x $1,000 = $ 950

A quote for a corporate bond of 97 1/4 translates into:

97.25% x $1,000 = $ 972.50

Read more: Bond Pricing - Series 62 | Investopedia

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Learning Objective

1. What are debt instruments and how are they priced?

Believe it or not, you are now equipped to calculate the price of any debt instrument or contract
provided you know the rate of interest, compounding period, and the size and timing of the
payments. Four major types of instruments that you are likely to encounter include discount
bonds, simple loans, fixed-payment loans, and coupon bonds.

A discount bond (aka a zero coupon bond or simply a zero) makes only one payment, its face
value on its maturity or redemption date, so its price is easily calculated using the present value
formula. If the interest rate is 6 percent, the price of a discount bond with a $1,000 face value due
in exactly a year would be $943.40 (1000/1.06). If the interest rate is 12 percent, the same
discount bond’s price would be only $892.86 (1000/1.12). If the bond is due in two years at 12
percent, its price would be $797.19 (1000/(1.122), and so forth.

A simple loan is the name for a loan where the borrower repays the principal and interest at the
end of the loan. Use the future value formula to calculate the sum due upon maturity. For
example, a simple loan of $1,000 for one year at 3.5 percent would require the borrower to repay
$1,035.00 (1000× 1.035), while a simple loan at the same rate for two years would require a
payment of $1,071.23 (1000 × 1.0352). (Note that the correct answer is not just $35 doubled due
to the effects of compounding or capitalizing the interest due at the end of the first year.)

A fixed-payment loan (aka a fully amortized loan) is one in which the borrower periodically (for
example, weekly, bimonthly, monthly, quarterly, annually, etc.) repays a portion of the principal
along with the interest. With such loans, which include most auto loans and home mortgages, all
payments are equal. There is no big balloon or principal payment at the end because the principal
shrinks, slowly at first but more rapidly as the final payment grows nearer, as in Figure 4.2
"Sample thirty-year amortizing mortgage".

Principal borrowed: $500,000.00; Annual number of payments: 12; Total number of payments:
360; Annual interest rate: 6.00%; Regular monthly payment amount: $2,997.75

Figure 4.2 Sample thirty-year amortizing mortgage

Today, such schedules are most easily created using specialized financial software, including
Web sites like,, or If you wanted to buy this mortgage (in
other words, if you wanted to purchase the right to receive the monthly repayments of $2,997.75)
from the original lender (there are still secondary markets for mortgages, though they are less
active than they were before the financial crisis that began in 2007), you’d simply sum the
present value of each of the remaining monthly payments. (Again, a computer is highly
recommended here!)

Finally, a coupon bond is so-called because, in the past, owners of the bond received interest
payments by clipping one of the coupons and remitting it to the borrower (or its paying agent,
usually a bank). Figure 4.3 "Sample bond coupon, Malden & Melrose Railroad Co., 1860", for
example, is a coupon paid (note the cancellation holes and stamp) to satisfy six months’ interest
on bond number 21 of the Malden & Melrose Railroad Company of Boston, Massachusetts,
sometime on or after April 1, 1863. Figure 4.4 "Michigan Central Railroad, 3.5 percent bearer
gold bond with coupons attached, 1902" is a $1,000 par value coupon bond issued in 1902, with
some of the coupons still attached (on the left side of the figure).

Figure 4.3 Sample bond coupon, Malden & Melrose Railroad Co., 1860

Courtesy of

Figure 4.4 Michigan Central Railroad, 3.5 percent bearer gold bond with coupons attached, 1902
Museum of American Finance

Even if it no longer uses a physical coupon like those illustrated in Figure 4.3 "Sample bond
coupon, Malden & Melrose Railroad Co., 1860" and Figure 4.4 "Michigan Central Railroad, 3.5
percent bearer gold bond with coupons attached, 1902", a coupon bond makes one or more
interest payments periodically (for example, monthly, quarterly, semiannually, annually, etc.)
until its maturity or redemption date, when the final interest payment and all of the principal are
paid. The sum of the present values of each future payment will give you the price. So we can
calculate the price today of a $10,000 face or par value coupon bond that pays 5 percent interest
annually until its face value is redeemed (its principal is repaid) in exactly five years if the
market rate of interest is 6 percent, 4 percent, or any other percent for that matter, simply by
summing the present value of each payment:

PV1 = $500/(1.06) = $471.70 (This is the interest payment after the first year. The $500 is the
coupon or interest payment, which is calculated by multiplying the bond’s face value, in this
case, $10,000, by the bond’s contractual rate of interest or “coupon rate,” in this case, 5 percent.
$10,000 × .05 = $500.)
P V 2 = $ 500 / ( 1.06 ) 2 = $ 445.00 (If this doesn’t look familiar, you didn’t do Exercise 1 enough!) P V 3
= $ 500 / ( 1.06 ) 3 = $ 419.81 P V 4 = $ 500 / ( 1.06 ) 4 = $ 396.05 P V 5 = $ 10,500 / ( 1.06 ) 5 = $ 7,846.21
($10,500 is the final interest payment of $500 plus the repayment of the bond’s face value of $10,000 .)

That adds up to $9,578.77. If you are wondering why the bond is worth less than its face value,
the key is the difference between the contractual interest or coupon rate it pays, 5 percent, and
the market rate of interest, 6 percent. Because the bond pays at a rate lower than the going
market, people are not willing to pay as much for it, so its price sinks below par. By the same
reasoning, people should be willing to pay more than the face value for this bond if interest rates
sink below its coupon rate of 5 percent. Indeed, when the market rate of interest is 4 percent, its
price is $10,445.18 (give or take a few pennies, depending on rounding):

P V 1 = $ 500 / ( 1.04 ) = $ 480.77 P V 2 = $ 500 / ( 1.04 ) 2 = $ 462.28 P V 3 = $ 500 / ( 1.04 ) 3 = $ 444.50

P V 4 = $ 500 / ( 1.04 ) 4 = $ 427.40 P V 5 = $ 10,500 / ( 1.04 ) 5 = $ 8,630.23

If the market interest rate is exactly equal to the coupon rate, the bond will sell at its par value, in
this case, $10,000.00. Check it out:

P V 1 = $ 500 / ( 1.05 ) = $ 476.1905 P V 2 = $ 500 / ( 1.05 ) 2 = $ 453.5147 P V 3 = $ 500 / ( 1.05 ) 3 = $

431.9188 P V 4 = $ 500 / ( 1.05 ) 4 = $ 411.3512 P V 5 = $ 10,500 / ( 1.05 ) 5 = $ 8,227.0247

Calculating the price of a bond that makes quarterly payments over thirty years can become quite
tedious because, by the method shown above, that would entail calculating the PV of 120 (30
years times 4 payments a year) payments. Until not too long ago, people used special bond tables
to help them make the calculations more quickly. Today, to speed things up and depending on
their needs, most people use financial calculators, specialized financial software, and canned
spreadsheet functions like Excel’s PRICEDISC or PRICEMAT, custom spreadsheet formulas, or
Web-based calculators like or

What are the different types of debt mutual funds in

There are broadly seven types of debt mutual funds in India.

Gilt Funds:
Gilt funds invest in Government securities with varying maturities. Average maturities of
government bonds in the portfolio of long term gilt funds are in the range of 15 to 30 years. The
fund manager in long term gilt funds actively manage their portfolio and take duration calls with
outlook on the interest rate. The returns of these funds are highly sensitive to interest rates
movements. The NAVs of gilt funds can be extremely volatile. The primary objective of Gilt
Funds is capital appreciation. Investors with moderate to high risk tolerance level, looking for
capital appreciation, can invest in Gilt Funds.

Income Funds:
Income funds invest in a variety of fixed income securities such as bonds, debentures and
government securities, across different maturity profiles. For example they can invest in 2 to 3
year corporate non convertible debenture and at the same time invest in a 20 year Government
bond. Their investment strategy is a mix of both hold to maturity (accrual income) and duration
calls. This enables them to earn good returns in different interest rate scenarios. However, the
average maturities of securities in the portfolio of income funds are in the range of 7 to 20 years.
Therefore, these funds are also highly sensitive to interest rate movements. However, the interest
rate sensitivity of income funds is less than gilt funds. Investors with moderate to high risk
tolerance level, looking for both income and capital appreciation in different interest rate
scenarios, can invest in income funds.

Short Term Debt Funds:

Short term bond funds invest in Commercial Papers (CP), Certificate of Deposits (CD) and short
maturity bonds. The average maturities of the securities in the portfolio of short term bond funds
are in the range of 2 – 3 years. The fund managers employ a predominantly accrual (hold to
maturity) strategy for these funds. Short term debt funds are suitable for investors with low risk
tolerance, looking for stable income.

Credit Opportunities Funds:

Credit opportunities fund are similar to short term debt funds. The fund managers lock in a few
percentage points of additional yield by investing in slightly lower rated corporate bonds.
Despite the slightly lower credit rating of the bonds in the credit opportunities fund portfolio, on
an average, majority of the bonds in the fund portfolios are rated AAA and AA. The average
maturities of the bonds in the portfolio of credit opportunities funds are in the range of 2 – 3
years. The fund managers hold the bonds to maturity and so there is very little interest rate risk.
Credit Opportunities funds are suitable for investors with low risk tolerance, looking for slightly
higher income than short term debt funds.

Fixed Maturity Plans:

Fixed Maturity Plans (FMPs) are close ended schemes. In other words investors can subscribe to
this scheme only during the offer period. The tenure of the scheme is fixed. FMPs invest in fixed
income securities of maturities matching with the tenure of the scheme. This is done to reduce or
prevent re-investment risk. Since the bonds in the FMP portfolio are held till maturity, the returns
of FMPs are very stable. FMPs are suitable for investors with low risk tolerance, looking for
stable returns and tax advantage over an investment period of 3 years or more. They can provide
better post tax returns than bank fixed deposits and are attractive investment options when yields
are high.

Liquid Funds:
Liquid fund are money market mutual funds and invest primarily in money market instruments
like treasury bills, certificate of deposits and commercial papers and term deposits, with the
objective of providing investors an opportunity to earn returns, without compromising on the
liquidity of the investment. Typically they invest in money market securities that have a residual
maturity of less than or equal to 91 days. Liquid funds give higher returns than savings bank.
Unlike savings bank interest, no tax is deducted at source for liquid fund returns. There is no exit
load. Withdrawals from liquid funds are processed within 24 hours on business days. Liquid
funds are suitable for investors who have substantial amount of cash lying idle in their savings
bank account.

Monthly Income Plans:

Monthly income plans are debt oriented hybrid mutual funds. These funds invest 75 – 80% of
their portfolio in fixed income securities and the 20 – 25% in equities. The equity portion of the
portfolio of Monthly Income Plans provides a kicker to the generally stable returns generated by
the debt portion of the portfolio. Monthly income plans can generate higher returns from pure
debt funds. However, the risk is also slightly higher in monthly income plans compared to most
of the other debt fund categories.

Liquid Funds

What Is A Liquid Fund?

Many a times, we come into possession of surplus funds which must be invested. But fixed
deposits are not an option as they have a lock in period which cuts off access to the cash. In such
a situation, a liquid fund can become one of the most beneficial investment options. Unlike
savings deposits which provide only minimal interest, liquid funds will allow you to earn better
interest on your invested capital.

In investment terms, the term ‘liquid’ refers to something which is as mobile as hard cash. For
instance, real estate is the least ‘liquid’ of assets, while a savings deposit is one of the most
‘liquid’ assets. Hence, liquid funds are a type of mutual fund / debt fund whose redemption
period is less than 24 hours. These funds make investments mainly in money market instruments
like commercial papers, certificate of deposits, term deposits and treasury bills.
The lock-in period of liquid funds can go up to a maximum of 3 days while the encashment of
the proceeds takes place within 24 hours. Some liquid funds may have a lock-in period of up to a
week or even a month.

One of the characteristic features of liquid funds is that the underlying assets of the fund have a
lower maturity period which can be helpful for the fund manager in times when redemption
demands have to be met.

Is Income From Liquid Funds Taxable?

Capital gains from liquid funds are subject to tax. In case the funds are sold within three years
(36 months), they will attract short-term capital gains tax. The rate of tax will be determined
based on the income tax slab under which the individual falls. In case the funds are sold after
three years, they will be subject to long-term capital gains tax which will be levied at 20% with
the benefit of indexation.

Floating Rate Fund

What is a 'Floating Rate Fund'
A floating rate fund is a fund that invests in financial instruments paying a variable or floating
interest rate. A floating rate fund invests in bonds and debt instruments whose interest payments
fluctuate with an underlying interest rate level, as opposed to paying fixed-rate income. The
biggest advantage of a floating rate fund is its lower degree of sensitivity to changes in interest
rates compared with a fund or instrument with a fixed payment rate. Floating rate funds appeal to
investors when interest rates are rising, since this will result in a higher level of interest or
coupon payments.

BREAKING DOWN 'Floating Rate Fund'

Floating rate funds are an attractive investment for the fixed income or conservative portion of
any portfolio. A floating rate fund can hold various types of floating rate debt including bonds
and loans. These funds are managed with varying objectives similar to other credit funds.
Strategies can target credit quality and duration. The rates payable on a floating rate instrument
held within a floating rate fund vary in line with a defined interest rate level. Therefore they are
less sensitive to duration risks. Income paid from the fund’s underlying investments is managed
by the portfolio managers and paid to shareholders through regular distributions. Distributions
may include income and capital gains. Distributions are often paid monthly but they can also be
paid quarterly, semi-annually or annually.

Apart from their lower sensitivity to interest rate changes and ability to reflect current interest
rates, a floating rate fund enables an investor to diversify fixed-income investments, since fixed-
rate instruments often comprise the majority of bond holdings for most investors. Another
benefit is that a floating rate fund enables an investor to acquire a diversified bond or loan
portfolio at a relatively low investment threshold, rather than investing in individual instruments
at a larger dollar amount.

In evaluating a floating rate fund, investors must ensure that the securities a fund holds are
adequate for their risk tolerance. Floating rate funds offer varying levels of risk across the credit
quality spectrum with high yield, lower credit quality investments carrying considerably higher
risks with greater potential for higher returns.

Floating Rate Fund Investments

Floating rate funds can include any type of floating rate instrument. The majority of floating rate
funds typically invest in floating rate bonds or loans. Below are two of the top performing funds
from 2017.

Catalyst/Princeton Floating Rate Income Fund (CFRAX)

The Catalyst/Princeton Floating Rate Income Fund had a one year return of 7.07% through
December 14, 2017. The Fund invests primarily in corporate senior secured floating rate bank
loans. The majority of the Fund’s loans have a credit rating of BBB and B. The Fund pays
monthly distributions. As of December 14 it had a net asset value of $9.57 with a trailing twelve
month distribution yield of 4.22%.

Hartford Floating Rate High Income Fund (HFHAX)

The Hartford Floating Rate High Income Fund had a one year return of 5.08% through
December 14, 2017. The Fund invests primarily in U.S. and global floating rate bank loans. Over
90% of the portfolio is invested in loans with BB and B credit ratings. The Fund pays monthly
distributions. As of December 14 it had a net asset value of $10.02 with a trailing twelve month
distribution yield of 3.76%.

What is Fixed Interest Rate?

If you choose fixed interest rate, it means that you will be repaying the home loan in fixed equal
instalments throughout the loan term. The main highlight of this type of interest rate is that it is
unaffected by market fluctuations. If you are very particular about budgeting and prefer to plan
out your repayment schedule with a fixed monthly amount, this type of interest rate would
interest you more as it gives a sense of certainty. The main disadvantage of fixed interest rate is
that that they are usually 1-2.5 percentage points higher than the floating rate home loan. Another
drawback is that in case the interest rate decreases, you will not be able to take advantage of the
reduced rates and will have to continue paying the same amount. It is important that you check
the fine print and see whether the fixed rate home loan is fixed for the entire tenure or only for a
few years. If you see the economic scenario promising a rise in interest rates in the near future,
fixed rates would be a better option

Benefits of Fixed Interest Rate

 As the name suggests, the fixed interest rate remains constant for the entire loan tenure. This
rate of interest doesn’t vary according to the rise and fall in the market.
 Since this interest rate doesn’t fluctuate over time, you will have to pay a fixed monthly
installment throughout the tenure. Therefore, you can easily and accurately plan your finances
under this type of rate of interest.

 It is the best option for people who are good at budgeting and prefer a fixed EMI schedule.

 If the economic conditions indicate that there are chances of a rise in the interest rates in the
future, this is the best option that a borrower should choose in order to ensure that he or she
can continue to pay a smaller amount as interest.

Drawbacks of Fixed Interest Rate

 The fixed interest rate is usually 1% to 2.5% higher than the floating interest rate offered by a
bank or non-banking financing company (NBFC).
 Even if the fixed interest rate reduces after an announcement from the Government or Reserve
Bank of India (RBI), it doesn’t affect the loans already borrowed using the previous interest rate.
The borrower will have to continue repayment at the higher interest rate even after a rate cut.

 Many a times, the fixed rate of interest is only valid for a couple of years. In that case, once this
period is over, the interest rate will get revised according to the ongoing rate. This might not be a
beneficial plan in the long run.

Why choose a Fixed Interest Rate?

See the reasons you should go for this interest rate option mentioned below:

 You prefer a fixed repayment schedule and are comfortable paying the current interest amount.
You should ensure that your monthly installment isn’t more than 30% of your net monthly salary.
 You foresee a rise in the interest rate in the future and, therefore, want to ensure that your
interest amount doesn’t increase more than what you are currently paying. In such a scenario,
the fixed interest rate can be used to lock in the current rate of interest being offered by the
lending organisation.

 In case there has been a recent decline in the interest rates and you are comfortable repaying
your loan at this rate, you can opt for a fixed rate of interest while borrowing a loan.

What is Floating Interest Rate?

As the name suggests, floating interest rate varies with the market scenario. If you opt for a home
loan with a floating interest rate, it means that you will be subjected to a base rate and a floating
element will be added. This means that if the base rate changes, the floating rate will also vary.
The main highlight of floating interest rate is that they are cheaper than fixed interest rate. For
example, if the fixed interest rate is 14% and floating interest rate is 11.5%, you will still be
saving money even if the floating interest rate rises by 2.5% points. Further, even if the floating
interest rate rises above the fixed rate, it will be temporary, and not for the entire tenure of the
loan. The main drawback of floating interest rate is the fact that it is difficult to budget as it may
change frequently. Planning your financials on a long term basis can be difficult with this type of
interest rate.

Benefits of Floating Interest Rate

 The floating interest rates offered by a bank or non-banking financing company is usually lower
than the fixed rates it offers its customers. Therefore, it means that even if the floating interest
rate increases, it can still be less than the previous fixed interest rate offered.
 In case the floating interest rate exceeds the interest rate, it will not be for the entire loan
tenure. There are chances that the floating rates might come down after a certain period of

Drawbacks of Floating Interest Rate

 Due to the fluctuating nature of floating interest rates, the monthly installments of a particular
amount of loan will vary throughout the entire loan tenure.
 Attributed to the uneven monthly installments, it is very difficult to budget a loan with floating
rate of interests.

 Since it is not possible to have a fixed repayment schedule under this interest rate option, it can
lead you to pay more than you are comfortable paying. This can, therefore, cause you to have
less savings and no budget plan.

Why choose a Floating Interest Rate?

 You can go for a floating interest rate for your loan when you apprehend that the rates might
decrease in the future, thereby, reducing the total cost of the loan.
 If you are looking to save a little in as floating rates are usually set 1% to 2.5% lower than the
fixed interest rate offered by the same lending organisation

 This type of interest rate usually suits people who do not possess enough insight regarding the
market and, thus, want to stick to the market rates.

In conclusion, choosing the type of interest rate that you should go for is a personal choice. What
works for one individual may not necessarily be the best choice for you. If you prefer to plan
well ahead when it comes to your finances and not leave anything to chance, a fixed rate would
be better suited to your needs. This, however, comes with a higher price. Before you make a
decision, you must consider home loans with fixed and floating rates from different institutions.
Go through the fine print and ensure that you choose one that you are most comfortable with.

News About Fixed vs Floating Interest Rate

 Karur Vysya Bank revises MCLR

Karur Vysya Bank has revised the MCLR of the Bank and will be implemented starting
August 07, 2018. This is after the Reserve Bank of India decided to increase the marginal
cost of fund-based lending rate by 25 basis points in the third bi-monthly monetary policy
statement for 2018-19. The lending rate now stands at 6.50 percent. The overnight MCLR
and the one-month MCLR now stands at 8.55%. The three month, six month, and one
year MCLR currently stand at 8.90%, 9.35% and 9.55% respectively.

10 August 2018

 Rs.10,000 crore G-secs purchased by RBI through OMO

The Reserve Bank of India (RBI) has announced the purchase government securities (G-
secs). The purchase has been made under Open Market Operations (OMO). The move
was made after the assessment was made by the Reserve Bank of India of the prevailing
liquidity solutions. The Reserve Bank of India is now planning to raise Rs.10,000 crore
on 19th July. The bank is planning to do the same by multi-security auction which will be
done using multiple price method. Security wise breakdown has not been provided by the
bank yet. The announcement of results of the auction results will be made on the day of
the issue. Participants should ensure that requisite amount of securities are available on
their SGL on July 20 by 12 noon.

19 July 2018
 Fund management to be improved by RBI’s proposals on large loans

A SBI study has said that the draft guidelines on loan system for delivery of bank credit
made by the Reserve Bank of India will be very helpful in improving the intra-day fund
management and liquidity planning by large borrowers. The draft made by the RBI
specifies a minimum level of ‘loan component’ and a Credit Conversion Factor (CCF)
that is mandatory. Borrowers are now required to manage short term liquidity and the
working capital cycle. This move will also lead to the improvement in the management of
short term and intra-day liquidity by banks. There is also a possibility for the
development of term money market due to the withdrawals by customers under Working
Capital Demand Loans.

19 June 2018

 MCLR rates raised by 5 bps by Syndicate Bank

Syndicate bank has raised the marginal cost of funds based lending rate(MCLR) by 5
basis points(bps). The six month MCLR rate has now raised to 8.3 percent and the
revised one-year MCLR rate now stands at 8.5 percent. The bank has said that the revised
minimum lending rates will be effective from May 10.

24 May 2018

 All India Bank Retirees Federation has requested revised pension for bank

Although the inflation has gone up 10 times in the last 20 years, the basic pension for
retired bank employees has not been revised since then. Therefore, the All India Bank
Retirees Federation (AIBRF) has demanded that the union government look into revising
the basic pension for bank retirees. As of now, the family pension in banking is 15%
whereas in the government and RBI, it is 30%. In addition to revising the basic pension
and raising the amount of family pension, the government has been requested to resolve
all the pending issues.

According to Mr. Deshpande, the President of AIBRF, the consolidated sum in pension
funds of various banks is above Rs.12 lakh crore and has been increasing every year.
Therefore, it should be easier for the banks to fulfill the demands of the AIBRF. There
will likely be an increase in non-performing assets (NPAs) if the banks were privatised,
according to S.C. Jain, the General Secretary of AIBRF. As it is, the banking sector is
facing issues with growing NPAs at Rs.10 lakh crore which mostly belongs to corporate
What is portfolio churning?
Churning is a term applied to the practice of a broker conducting excessive trading in a client's
account mainly to generate commissions. Churning is an unethical and illegal practice that
violates SEC rules (15c1-7) and securities laws

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What is 'Churning'
Churning is a term applied to the practice of a broker conducting excessive trading in a client's
account mainly to generate commissions. Churning is an unethical and illegal practice that
violates SEC rules (15c1-7) and securities laws. While there is no quantitative measure for
churning, frequent buying and selling of securities that does little to meet the client's investment
objectives may be evidence of churning.

Next Up

1. Reverse Churning
2. Broker

3. Rules of Fair Practice

4. Agency Broker



Churning may often result in substantial losses in the client's account, or if profitable, may
generate a tax liability. Since churning can only occur when the broker has discretionary
authority over the client's account, a client may avoid this risk by maintaining full control.
Another way to prevent the chances of churning or of paying excessive commission fees is to use
a fee-based account. However, placing a customer in a fee-based account when there is little to
no activity to justify the fee is indicative of another form of churning called reverse churning.
Types of Churning
The most basic churning comes from excessive trading by a broker to generate commissions.
Brokers must justify commissionable trades and how they benefit the client. When there are
excessive commissions with no noticeable portfolio gains, churning might have occurred.

Churning also applies in the excessive or unnecessary trading of mutual funds and annuities.
Mutual funds with an upfront load (A shares) are long-term investments. Selling an A-share fund
within five years and purchasing another A-share fund must be substantiated with a prudent
investment decision. Most mutual fund companies allow investors to switch into any fund within
a fund family without incurring an upfront fee. A broker recommending an investment change
should first consider funds within the fund family.

Deferred annuities are retirement savings accounts that usually do not have an upfront fee like
mutual funds. Instead, annuities typically have contingent deferred surrender charges. Surrender
charge schedules vary and can range from 1 to 10 years. To prevent churning, many states have
implemented exchange and replacement rules. These rules allow an investor to compare the new
contract and highlight surrender penalties or fees.

Sanctions for Churning

Churning is a severe offense and, if proven, can lead to employment termination, barring from
the industry, and legal ramifications. Also, the Financial Industry Regulatory Authority (FINRA)
may impose fines ranging from $5,000 to $110,000 per instance. FINRA also has the right to
suspend the broker for anywhere from ten business days up to one year. In more egregious cases,
FINRA can suspend the violator for up to two years or even bar the broker indefinitely.