2011

Literature Review:

Topic: Performance on Mutual Funds as an effective investment compared to bank

deposits with respect to conservative risk profile investors.

Submitted by

Rogen Varghese Jacob

TKM Institute of Management

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Literature Review

MUTUAL FUND
In today’s market people invest money to gain more. So when they take into
account, they mostly look out for Investment Company where they can get more income. Mutual
funds now represent the most appropriate investment opportunity for all the investors whether
small or big. As financial markets become more sophisticated and complex, investors need a
financial intermediary who provides the required knowledge and professional expertise on
successful investing.
Investment companies can be classified into close-end and open-end investment
companies. Close-end is when it is readily transferable in the market. Open-end funds sell their
own shares to investors and ready to buy back their old shares. If we talk about investment
option today, in India we have so many investments companies like UTI, LIC etc. and all have
their own special ways of servicing the customers. The investors also feel that they are worth to
be the part of that company. These days’ people mainly look for avoiding tax so normally they
look out for some investments, which will help them to do so. When it comes to this point of
view, people mainly look for mutual fund.
A mutual fund is a trust that pools the savings of a number of investors who shares
a common financial goal. The money thus collected is invested by the fund manager in different
types of securities depending upon the objectives of the scheme. These could range from shares
to debentures to money market instruments and the capital appreciation realized by the scheme
are shared by the 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 portfolio at a relatively low cost. Markets for
equity shares, bonds and other fixed income instruments, real estates, derivatives and other assets
have become mature and information driven. Price changes in these assets are driven by global
events occurring in faraway places. A typical individual is unlikely to have knowledge, skills,
inclination, and time to keep track of events, understand their implications and act speedily. A
mutual fund is the answer to all these situations. It appoints professionally qualified and

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experienced staff that manages each of these functions on a full time basis. The large pool of
money collected in the fund allows it to heir such staffs at a very low cost of each
investor.
In effect, the mutual fund vehicle exploits economies of scale in all three areas –
Research, Investment and Transaction processing. While the concept of individual coming
together to invest money collectively is not new, the mutual fund in its present form is a 20th
century phenomena.

1.2 PLACE OF MUTUAL FUND IN FINANCIAL MARKETS

Indian households started allocating more of their savings to the capital markets
in 1980s, with investments flowing into equity and debt instruments, besides the conventional
mode of bank deposits. The birthplace of mutual fund was – the USA. The Indian mutual fund
industry is at a point of strategic inflection. It was founded with the establishment of UTI in
1964. The private sector mutual fund entered the scene in early 1990’s and introduced better
services standards and wider product choices. The Indian mutual fund industry has not
performed up to the mark in gaining investor confidence. The assets have been garnered based
on performance rather than confidence of investor. In the primary capital market, mutual funds
serve as a link between the saving public and the corporate sector, as they channelize savings
from investors to corporations. In the secondary capital markets, they participate as investors and
trade with other investors.

1.3 CONCEPTS AND ORIGIN OF MUTUAL FUND:

In a mutual fund, many investors contribute to form a common pool of money.
This pool of money is invested in accordance with a stated objective. The ownership of the fund
is thus joint or “mutual”- the funds belongs to all investors. A single investor’s ownership of the
fund is in the same proportion as the amount of contribution made by him bears to the total
amount of the fund.
A mutual fund uses the money collected from investors to buy those assets,
which are specifically permitted by its stated investment objective. Thus, a growth fund would

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buy mainly equity assets- ordinary shares, preferences shares, warrants, etc. An income fund
would mainly buy debt instruments such as debentures and bonds. The investors own the fund
assets in the same proportion as their contribution bears to the total contributions of all investors
put together.
In USA a mutual fund is constituted as an investment company and an investor
“buys into the funds”, meaning he buys the shares of the fund. In India, a mutual fund is
constituted as a Trust and the investor subscribes to the “units” of a scheme launched by the
fund, which is where the term Unit trust comes from. In any case, a mutual fund shareholder or
unit-holder is a part owner of the funds’ assets.
The basic principles of investment trusts are diversifying the securities purchased for
the trust and expert management. It reduces the risk of capital depreciation and poor dividends.
At the same time the investors are given the benefit of expert management through trained
experienced and specialized personnel, which lacks in the ordinary investors.
There are two main types of investment companies. The first group is variously called
management investment trust or closed end companies in U.S.A and Japan. The second are the
unit trust type and the most important one. These are referred to as open-end investment
companies or as mutual funds as they are usually called.

1.4 MEANING OF MUTUAL FUND

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 by the fund manager in different
types of securities depending upon the objective of the scheme. These could range from shares to
debentures to money market instruments. The income earned through these investments and the
capital appreciations realized by the scheme are shared by its unit holder. . 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 portfolio at a relatively low cost.
Mutual fund is also called unit trust or open ended trust a company that invests the
funds of its clients in diversified securities and in turn represent those holdings. They make

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continuous offering of new shares at NAV (Net Asset Value) determined daily by the market
values of the securities they hold.

1.5 DEFINATION
Different persons in different words have defined mutual fund:
The SEBI (MF) Regulation, 1993 defines mutual fund as “A fund established in the
form of a trust by a sponsor to raise monies by the trustees through the sale of units to the public
under one or more schemes for investing in securities in accordance with these regulations.”

1.6 Characteristics
 A mutual fund actually belongs to the investors who have pooled their funds.

 A mutual fund is managed by investment professionals and other service providers, who
earn a fee for their services, from the fund.

 The pool of funds is invested in a portfolio of marketable investments. The value of the
portfolio is updated every day.

 The investor’s share in the fund is denominated by “units”. The value of the units
changes with change in the portfolio’s value, every day. The value of one unit of
investment is called the Net Asset Value or NAV.

In modern times, one of the better investment avenues available, particularly for the small retail
investors is the avenue of mutual funds.
Mutual funds have the advantage of diversification and professional management. However,
some people hesitate to invest in mutual funds since they are unaware of the benefits that they
can reap. Skillful and highly experienced fund managers make investment judgment based on the
research and resources that most individual investors don’t have. They decide where to invest
their money based on market insight, not worrying about the hassle of monitoring the market or
relying on tips. Easy investment, affordability and professional money management make mutual
funds a simplified way for money to work.

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1.7 Mutual Fund Operation

Flow Chart

1.8 Regulatory Authorities

To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds.
It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time.
MF either promoted by public or by private sector entities including one promoted by foreign
entities is governed by these Regulations.

SEBI approved Asset Management Company (AMC) manages the funds by making investments
in various types of securities. Custodian, registered with SEBI, holds the securities of various
schemes of the fund in its custody.

According to SEBI Regulations, two thirds of the directors of Trustee Company or board of

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trustees must be independent.

The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual
funds that the mutual funds function within the strict regulatory framework. Its objective is to
increase public awareness of the mutual fund industry.

AMFI also is engaged in upgrading professional standards and in promoting best industry
practices in diverse areas such as valuation, disclosure, transparency etc.

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1.9 TYPES OF MUTUAL FUND

There are many types of mutual funds available to the investor. These different types
of funds can be grouped into certain classifications:.

1.9.1 ON THE BASIS OF STUCTURE:

a. Open ended funds:
An open-ended mutual fund is one that has units available for purchase and sale at all time at
NAV related prices. There is free entry and exit of investors. An open-ended fund rarely denies
to its investors the facility to redeem existing units subject to certain obvious conditions

b. Close ended funds:

Close-ended funds do not provide the facility of subscription throughout the year. It is open for a
subscription for a fixed duration as specified in the prospective of the fund. Investor can apply
for shares only during initial offer period, following which units can be bought & sold only at
the stock exchange where they are listed at market price.

c. Interval Funds
This is a mix of both open ended and close-ended schemes. For a certain stipulated period, an
investor can buy and sell NAV related prices, while at some times it is traded at stock exchange
where it is listed.

1.9.2 ON THE BASIS OF OBJECTIVES

a. Growth funds
Growth funds aim to achieve capital appreciation in the medium to long term. These funds do
not pay dividends, instead they reinvest the returns. Their assets usually comprises of equity, as it
has been proved that equity markets provide the maximum growth in returns among all other
assets classes.

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b. Income funds
Income funds aim at generating and distributing regular income to the members on a periodical
basis. Fund invests in fixed income assets such as corporate debentures, government securities,
bonds etc. it concentrate on short-term gains.

c. Balanced fund:
Balanced fund provided both growth as well as regular income to the investor. It aims at
distributing regular income as well as capital appreciation. This can be achieved by balancing the
investments between the high growth equity shares and fixed income securities.

d. Tax saving funds:

These schemes offer tax rebates to investors under specific provision of income tax act1961. It is
suitable to salaried people who want to enjoy tax rebates. Government offers tax incentives for
investment in specified avenues.

1.9.3 ON THE BASIS OF COMPOSITION OF FUNDS:

a. Equity funds:
Equity funds invest a major portion of their corpus in equity shares issued by companies. They
are riskiest, as they do not offer any guaranteed repayment NAV of equity funds fluctuates with
price moments caused by external factors like political, economic and social factors. Investors
who want capital appreciation should invest in these funds.

b. Debt funds:
Debt funds invest in debt investment issued by government, private companies, banks, financial
instruments etc. These funds provide low risks and stable income to the investors.
c. Money market mutual funds:
They invest in highly liquid and safe securities like commercial papers, certificates of deposits,
treasury bills etc. Money market funds offer liquidity and safety of principal that an investor can
expect from short-term funds.

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d. Gilt funds:
Gilt funds invest in government securities and treasury bill. These funds have less risk of default
and hence offer better protection of principal. These fund provide timely payment of principal
and interest.

e. Index fund:
Index funds are those funds where the portfolios are designed in such a way that they reflect the
composition of some broad market index. It holds securities in the same proportion as index. The
value of these indexes goes up whenever market index goes up and vice versa. The
performance of index fund exactly follows the performance stock index.

f. Sector funds:
Sector funds invest only in the stocks of particular industry or sector. These funds are riskier as
they are not diversified. Those investors who understand the industry or sector very well may
invest in these funds.

1.9.4 OTHER SCHEMES:

a. Loan funds:
Loan fund charge entry or exit load every time the investor buys or sells the units of funds. These
charges cover distribution, sales and marketing expenses. The load charges to the investor at the
time his entry into a scheme is called entry load. The load charged to the investor at the time of
exit from the scheme is called exit load.

b. No load funds:
The fund that do not charge entry or exit load on sale or purchase of their units.

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1.10 NET ASSET VALUE

Net asset value is the market value of the asset of the scheme minus its liabilities. The per unit
NAV is the net asset value of the scheme divided by the number of units outstanding on the
valuation date.

Net Asset Value (NAV) denotes the performance of a particular scheme of a mutual fund.
Mutual funds invest the money collected from the investors in securities markets. In simple
words, Net Asset Value is the market value of the securities held by the scheme. Since market
value of the securities changes every day, NAV of a scheme also varies on day-to-day basis.
The NAV per unit is the market value of securities of a scheme divided by the total number of
units of the scheme on any particular date. For example, if the market value of securities of a
mutual fund scheme is Rs200 lakhs and the mutual fund has issued 10 lakhs units of Rs 10 each
to the investors, then the NAV per unit of the fund is Rs 20. NAV is required to disclose by the
mutual fund on a regular basis – daily or weekly- depending on the type of scheme.

Sale price
It is the price you pay when you invest in a scheme. Also called as offer price. It may include a
sales load

Repurchase price
Is the price at which a close-ended scheme repurchases its units and it may include a back-end
load? This is also called Bid price.

Redemption price
Is the price at which open- ended scheme repurchase their units and close ended schemes redeem
their units on maturity. Such prices are NAV related.

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Sales load
Is a charge collected by a scheme when it sells the units. Also called , ‘Front-end’ load. Schemes
that do not charge a load are called ‘No Load’ schemes.

Repurchases or ‘Back-end’ load

Is a charge collected by a scheme when it buys back the units from the unit
holders.
1.11 BENEFITS OF INVESTING IN A MUTUAL FUND:

a) Professional management of the investment:

Mutual fund appoints an experienced and professional fund manager and several research
analysts, who research before investing, thus adding value to common investor. These
professionals constantly keep track of market changes and mews, predict the impact they will
have on the investments and take quick
decisions regarding the adjustments to be made in the portfolio.
HOW MUTUAL FUND IS A BETTER OPTION THAN OTHER INVESTMENT
b) Provides better yield:
Due to large amount of funds that the mutual fund manages, very low costs
accrue per investor. Mutual fund achieve economies of scale in research,
transaction and investment. It lowers the cost of brokerage custodial and other
charges. So they provide getter yields to their customers. All the profits of
mutual funds are passed on to the investors by way of dividend and capital
appreciation.
c) Diversification of risk:
A common investor has limited money, which he can invest only in few
securities, and faces a great risk. If their values go down the investor looses all
his money.
Since mutual funds have huge amounts of funds to invest the fund manager
invests in the securities of many industries and sectors. This diversification
reduces the risk involved because all the sector and industries will never go
down at the same time. Investors get their diversification by investing a small
amount in mutual fund.
d) Convenient record keeping and administration:
Mutual fund take care of all the record keeping including paperwork. It also
deals with the problem of bad deliveries broker’s commission etc.
HOW MUTUAL FUND IS A BETTER OPTION THAN OTHER INVESTMENT
e) Channelising the saving for investment:
Mutual fund acts as a vehicle in galvanizing the saving of the people by
offering various schemes suitable to the various classes of customers for
development of economy as a whole. Mutual find offers various types of

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schemes as regular income plan, growth plan, equity funds, debt funds and
balanced funds. The investor can select a plan according to his needs. In the
absence of mutual funds, these savings would have remained idle.
f) Flexibility:
Mutual fund has permitted investors to exchange their units from one
scheme to another. One cannot derive such flexibility in any other
investment.
g) Enables investing in high value stocks:
The individual investor have less money to invest thus cannot invest in blue
chip companies. Mutual funds have huge amount of funds and can invest in
these high value stocks. The benefits from these high value stocks can be
passed on to all investors.
h) Easy liquidity:
Units can be sold back to the fund at any time at the NAV and thus quick
access to liquid cash is assured. Besides branches of sponsoring bank also
provides loan against units certificates.
HOW MUTUAL FUND IS A BETTER OPTION THAN OTHER INVESTMENT
j) Provides Transparencies:
Mutual fund keeps the customers informed about the composition of all
investments in carious asset classes from time to time. During launch of
mutual fund the offer document provides information on the objectives of
the funds, cost to be incurred, entry or exit loads to be charged to the
investors, risk associated with fund, details about fund manager, sponsors
etc
k) Regulated by SEBI:
Mutual fund are also regulated by SEBI, like equities. This is to safeguard
the interest of the investors.
l) Tax benefits:
Certain fund offer tax benefits to the customers. Dividends in the hands of
the investors are exempted from tax. Investors can invest in such schemes
and save some tax.
1.1 HISTORY OF THE INDIAN MUTUAL FUND INDUSTRY:
The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the
initiative of the Government of India and Reserve Bank. The history of mutual funds in India can
be broadly divided into four distinct phases.

First Phase: 1964-1987

An Act of Parliament established Unit Trust of India (UTI) on 1963. It was set up by the Reserve
Bank of India and functioned under the Regulatory and administrative control of the RBI. In

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1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took
over the regulatory and administrative control in place of RBI. The first scheme launched by UTI
was Unit Scheme 1964. At the end of 1988 UTI had Rs.6,700 crores of AUM.

Second Phase: 1987-1993 (Entry of Public Sector Funds)

In 1987 marked the entry of non- UTI, public sector mutual funds set up by public sector banks
and Life Insurance Corporation of India (LIC) and General Insurance Corporation of India
(GIC). SBI Mutual Fund was the first non- UTI Mutual Fund established in June 1987.

Third Phase: 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund
industry, giving the Indian investors a wider choice of fund families. Also, 1993 was the year in
which the first Mutual Fund Regulations came into being, under which all mutual funds, except
UTI were to be registered and governed. The erstwhile Kothari Pioneer (now merged with
Franklin Templeton) was the first private sector mutual fund registered in July 1993. The
industry now functions under the SEBI (Mutual Fund) Regulations 1996.As at the end of January
2003; there were 33 mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of
India with Rs.44, 541 crores of assets under management was way ahead of other mutual funds.

Fourth Phase – Since February 2003

In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was bifurcated
into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets
under management of Rs.29, 835 crores as at the end of January 2003, representing broadly, the
assets of US 64 scheme, assured return and certain other schemes.The second is the UTI Mutual
Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under
the Mutual Fund Regulations.

1.11 Types of returns

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There are three ways, where the total returns provided by mutual funds can be enjoyed by
investors:

 Income is earned from dividends on stocks and interest on bonds. A fund pays out nearly
all income it receives over the year to fund owners in the form of a distribution.

 If the fund sells securities that have increased in price, the fund has a capital gain. Most
funds also pass on these gains to investors in a distribution.

 If fund holdings increase in price but are not sold by the fund manager, the fund's shares
increase in price. You can then sell your mutual fund shares for a profit. Funds will also
usually give you a choice either to receive a check for distributions or to reinvest the
earnings and get more shares.

1.12COMPETITION IN MUTUAL FUND INDUSTRY:

Mutual fund is the industry, which is facing severe competition from the other financial products.
The four types of competition in the mutual fund industry is as follows:
 Inter-industry competition
 Intra- industry competition
 Competition between the different mutual fund schemes
 Competition between the different asset management companies.

1.13 STUCTURE OF THE INDIAN MUTUAL FUND

INDUSTRY:

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Structure wise mutual fund industry can be classified into three categories;

a. Unit trust of India

The Indian mutual fund industry is dominated by the unit trust of India, which has a total corpus
of 51000 crore collected from over 20 million investors. The UTI has many fund/ schemes in all
categories in equity, balanced, debt, money market etc. With some being open ended and some
being closed ended. The unit scheme 1964 commonly referred to as US64, which is a balanced
fund, is the biggest scheme with a corpus of about 10000 crore.

b. Public sector mutual fund

The second largest categories of mutual funds are the ones floated by nationalized banks. Can
bank asset management floated by canara bank and SBI funds management floated by state bank
of India are the largest of these. GIC AMC floated by general Insurance Corporation.

On line trading is a great idea to reduce management expenses from the current 2%
of total assets to about 0.75%of the total asset.
• 72% of the crore-customer base of mutual fund in the top 50-broking firms in the
US is expected to trade on line by 2003.

c. Private Sector Mutual fund

The third largest categories of mutual funds are the ones floated by the private sector domestic
mutual funds and the private sector foreign mutual funds. The largest of these in private sector
domestic mutual funds are Reliance mutual fund, JM capital management company ltd. Tata
mutual, Birla sun life asset management pvt Ltd. and in private foreign mutual funds these are
alliance capital asset management private ltd, Franklin Templeton Investments, Sun F&C asset
management private ltd, Lurich asset management company pvt ltd. The aggregate corpus of the
assets managed by this category of amc’s is about 42000 cr.

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1.14 GLOBAL SCENARIO OF MUTUAL FUND:

 The money market mutual fund segment has a total corpus of 1.48 trillion in the
U.S.
 Out of the top 10 mutual fund worldwide, eight are worldwide sponsored. Only
fidelity and capital are non-bank mutual funds in this group.
 In the U.S. the total numbers of schemes is higher than that of the listed companies.
 Internationally, mutual funds are allowed to go short. In India fund managers do not
have such leeway.
 In the U.S. about 9.7 million households will manage their assets online by the year
2003, such a facility is not yet of avail in India and jeevan bima sahayog amc floated by
the LIC are some of the other prominent ones. The aggregate corpus of the funds
managed by this category of amc’s is around 8300 cr.

1.15Advantages of Investing Mutual Funds

Mutual Funds offer several benefits to an investor that are unmatched by the other investment
options. Last six years have been the most turbulent as well as exiting ones for the industry. New
players have come in, while others have decided to close shop by either selling off or merging
with others. Product innovation is now passé with the game shifting to performance delivery in
fund management as well as service. Those directly associated with the fund management

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industry like distributors, registrars and transfer agents, and even the regulators have become
more mature and responsible.

1. Professional Management - The basic advantage of funds is that, they are professional
managed, by well qualified professional. Investors purchase funds because they do not have the
time or the expertise to manage their own portfolio. A mutual fund is considered to be relatively
less expensive way to make and monitor their investments.
2. Diversification - Purchasing units in a mutual fund instead of buying individual stocks or
bonds, the investors risk is spread out and minimized up to certain extent. The idea behind
diversification is to invest in a large number of assets so that a loss in any particular investment
is minimized by gains in others.
3. Economies of Scale - Mutual fund buy and sell large amounts of securities at a time, thus help
to reducing transaction costs, and help to bring down the average cost of the unit for their
investors.
4. Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate their
holdings as and when they want.
5. Simplicity - Investments in mutual fund is considered to be easy, compare to other available
instruments in the market, and the minimum investment is small. Most AMC also have automatic
purchase plans whereby as little as Rs. 2000, where SIP start with just Rs.50 per month basis.
6. Affordability - Small investors with low investment fund are unable to invest in high-grade or
blue chip stocks. An investor through Mutual Funds can be benefited from a portfolio including
of high priced stock.
7. Regulation: All Mutual Funds are registered with SEBI and they function within the
provisions of strict regulations designed to protect the interests of investors. The operations of
Mutual Funds are regularly monitored by SEBI.

1.16 Disadvantages of Investing Mutual Funds:

1. Professional Management- Some funds don’t perform in the market, as their management is
not dynamic enough to explore the available opportunity in the market, thus many investors

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debate over whether or not the so-called professionals are any better than mutual fund or investor
himself, for picking up stocks.

2. Costs – The biggest source of AMC income is generally from the entry & exit load which they
charge from investors, at the time of purchase. The mutual fund industries are thus charging
extra cost under layers of jargon.

3. Dilution - Because funds have small holdings across different companies, high returns from a
few investments often don't make much difference on the overall return. Dilution is also the
result of a successful fund getting too big. When money pours into funds that have had strong
success, the manager often has trouble finding a good investment for all the new money.

4. Taxes - when making decisions about your money, fund managers don't consider your
personal tax situation. For example, when a fund manager sells a security, a capital-gain tax is
triggered, which affects how profitable the individual is from the sale. It might have been more
advantageous for the individual to defer the capital gains liability.

5. No control over cost: Since investor does not directly monitor the fund’s operations, they
cannot control the costs effectively. Regulators therefore usually limit the expenses of mutual
funds.

6. Non-availability of loans: Mutual funds are not accepted as security against loan. The
investor cannot deposit the mutual funds against taking any kind of bank loans though they may
be his assets.

7. No tailor-made portfolio: Mutual fund portfolios are created and marketed by AMCs, into
which investors invest. They cannot made tailor made portfolio.

1.17 RISK INVOLVED IN MUTUAL FUND

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1. MARKET RISK:
Sometimes prices and yields of all securities rise and fall. Broad outside influences affecting the
market in general lead to this. This is true, may it be big corporations or smaller mid-sized
companies. This is known as Market Risk.

2. CREDIT RISK:
The debt servicing ability (may it be interest payments or repayment of principal) of a company
through its cash flows determines the Credit Risk faced by you. This credit risk is measured by
independent rating agencies like CRISIL who rate companies and their paper. An „AAA‟ rating
is considered the safest whereas a „D‟ rating is considered poor credit quality. A well-diversified
portfolio might help mitigate this risk.

3. INFLATION RISK:
Inflation is the loss of purchasing power over time. A lot of times people make conservative
investment decisions to protect their capital but end up with a sum of money that can buy less
than what the principal could at the time of the investment. This happens when inflation grows
faster than the return on your investment. A well-diversified portfolio with some investment in
equities might help mitigate this risk.

4. INTEREST RATE RISK:

In a free market economy interest rates are difficult if not impossible to predict. Changes in
interest rates affect the prices of bonds as well as equities. If interest rates raise the prices of
10 bonds fall and vice versa. Equity might be negatively affected as well in a rising interest rate
environment. A well-diversified portfolio might help mitigate this risk.

5. POLITICAL/GOVERNMENT POLICY RISK:

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Changes in government policy and political decision can change the investment environment.
They can create a favorable environment for investment or vice versa.

6. LIQUIDITY RISK:
Liquidity risk arises when it becomes difficult to sell the securities that one has purchased.
Liquidity Risk can be partly mitigated by diversification, staggering of maturities as well as
internal risk controls that lean towards purchase of liquid securities.

1.18 FACTORS AFFECTING MUTUAL FUND

1. Governmental Influences
Mutual fund business is a highly regulated business throughout the world as it seeks to ensure
that quality and fairly priced schemes are available. Governmental intervention thus in mutual
fund market usually is most needed to ensure that insurers are reliable. And in the developing
countries the additional goal may be promotion of domestic mutual fund industry and ensuring
the national mutual fund industry contributes to overall economic development. In a non-
technical sense mutual fund is purchased in a good faith so the duty of government intervention
in mutual fund industry is to ensure that this principle of mutual fund is never defeated.

2. Taxation Policy
Social equity being one of the motives behind tax collections, government gives certain
exemptions from such levying. One such exemption is deduction incurred by taxpayers towards
investment in mutual fund coverage. Similarly, capital invested in infrastructure bonds etc. is
offered with certain concession under tax laws. The central idea behind such exemptions is that
the capitals so allocated by individuals reduce the ultimate burden on the public infrastructure or
helps in creating such infrastructural facilities.

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3. Foreign Trade Regulations

With the vast potential for mutual fund in India due its large population in the country many
foreign companies are ready to enter into the Indian market. But companies can be permitted in
India through joint ventures with an Indian partner as well as come separately and the foreign
equity shall be restricted to only 25%. Another statement also tells that Indian subsidiaries of
foreign companies shall not be allowed to participate in banking sector unless they entered in to
joint ventures with the Indian partners.

4. National Income
The relative importance of the mutual fund Market within a country will also be dependent upon
economic development. With greater rates of economic growth, consumption of investment
should increase as a result of increased income, and an increased stock of assets requiring mutual
fund. Furthermore, the development of mutual fund is likely to facilitate greater economic
growth, implying that economic growth may be endogenous. Consistent with these arguments,
studies find that the level of financial development and economic development are positively
related to the level of mutual fund across emerging markets.

5. Employment
The effect of employment on mutual fund industry is as direct as that on economic development
of any country. With the rising levels of employment the effect on mutual fund industry is
positive because employment adds to the insured properties and assets from every prospective be
it due to organized or unorganized.

6. Interest
Interest is major factor for investment when a person find less return from investment tool than
people move towards the higher returns tool of investment.

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2. BANK DEPOSITS
A bank has three sources of funds namely (i) bank’ capital, (ii) bank’s reserves
or retained earnings and (iii) deposits. Among the three sources, deposits form the main
component of a bank’s source of funds. The basic concept is that deposits are the foundation
upon which banks thrive and grow. They provide the most raw materials for bank loans and
other investments (Rose, 2002: 387) from which a bank derives its main source of interest
income. Despite increasing diversification towards fee-based income from projects and financial
advisory services, banks are relying greatly on interest-bearing deposits and assets to generate
interest income and profits (Rose, 1997). Hence, banks compete aggressively to source more

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deposits from its customers, which can be government, suppliers, corporations, investors or
households
Money placed into a banking institution for safekeeping. Bank deposits are made to
deposit accounts at a banking institution, such as savings accounts, checking accounts and
money market accounts. The account holder has the right to withdraw any deposited funds, as set
forth in the terms and conditions of the account. The "deposit" itself is a liability owed by the
bank to the depositor (the person or entity that made the deposit), and refers to this liability rather
than to the actual funds that are deposited.
Bank deposits serve different purposes for different people. Some people cannot save
regularly; they deposit money in the bank only when they have extra income. The purpose of
deposit then is to keep money safe for future needs. Some may want to deposit money in a bank
for as long as possible to earn interest or to accumulate savings with interest so as to buy a flat,
or to meet hospital expenses in old age, etc. Some, mostly businessmen, deposit all their income
from sales in a bank account and pay all business expenses out of the deposits. Keeping in view
these differences, banks offer the facility of opening different types of deposit accounts by
people to suit their purpose and convenience.
For consenting to mobilize their deposits, depositors are rewarded with a pre-determined
rate of return by the bank. The rate of return depends on the type of deposits, the deposit amount,
the length of the maturity periods and the bank’s cost of funds. In banking, market interest rate is
very instrumental in determining the deposit rate.

2.1 Types of Bank Deposits

On the basis of purpose they serve, bank deposit accounts may be classified as follows:
a. Savings Bank Account
b. Current Deposit Account
c. Fixed Deposit Account
d. Recurring Deposit Account.

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a. Savings Bank Account: If a person has limited income and wants to save money for future
needs, the Saving Bank Account is most suited for his purpose. This type of account can be
opened with a minimum initial deposit that varies from bank to bank. Money can be deposited
any time in this account. Withdrawals can be made either by signing a withdrawal form or by
issuing a cheque or by using ATM card. Normally banks put some restriction on the number of
withdrawal from this account. Interest is allowed on the balance of deposit in the account. The
rate of interest on savings bank account varies from bank to bank and also changes from time to
time. A minimum balance has to be maintained in the account as prescribed by the bank.

b. Current Deposit Account: Big businessmen, companies and institutions such as schools,
colleges, and hospitals have to make payment through their bank accounts. Since there are
restrictions on number of withdrawals from savings bank account, that type of account is not
suitable for them. They need to have an account from which withdrawal can be made any
number of times. Banks open current account for them. Like savings bank account, this account
also requires certain minimum amount of deposit while opening the account. On this deposit
bank does not pay any interest on the balances. Rather the accountholder pays certain amount
each year as operational charge.
For the convenience of the accountholders banks also allow withdrawal of amounts in excess of
the balance of deposit. This facility is known as overdraft facility. It is allowed to some specific
customers and up to a certain limit subject to previous agreement with the bank concerned.

c. Fixed Deposit Account (also known as Term Deposit Account): Many a time people want
to save money for long period. If money is deposited in savings bank account, banks allow a
lower rate of interest. Therefore, money is deposited in a fixed deposit account to earn a interest
at a higher rate.
This type of deposit account allows deposit to be made of an amount for a specified period. This
period of deposit may range from 15 days to three years or more during which no withdrawal is

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allowed. However, on request, the depositors can encash the amount before its maturity. In that
case banks give lower interest than what was agreed upon. The interest on fixed deposit account
can be withdrawn at certain intervals of time. At the end of the period, the deposit may be
withdrawn or renewed for a further period. Banks also grant loan on the security of fixed deposit
receipt.

d. Recurring Deposit Account: This type of account is suitable for those who can save
regularly and expect to earn a fair return on the deposits over a period of time. While opening the
account a person has to agree to deposit a fixed amount once in a month for a certain period. The
total deposit along with the interest therein is payable on maturity. However, the depositor can
also be allowed to close the account before its maturity and get back the money along with the
interest till that period. The account can be opened by a person individually or jointly with
another, or by the guardian in the name of a minor. The rate of interest allowed on the deposits is
higher than that on a savings bank deposit but lower than the rate allowed on a fixed deposit for
the same period.
Recurring Deposit Accounts may be of different types depending on the purpose
underlying the deposit. Some of these are as follows:

a. Home Safe Account (also known as Money Box Scheme): Small savers find it convenient
to deposit money under this scheme. For regular savings, the bank provides a safe or box
(Gullak) to the depositor. The safe or box cannot be opened by the depositor, who can put money
in it regularly, which is collected by the bank’s representative at intervals and the amount is
credited to the depositor’s account. The deposits carry a nominal rate of interest.

b. Cumulative-cum-Sickness Deposit Account: Regular deposits made in this type of account

serve the purpose of having money to meet large expenses in case there is sudden illness or other
unforeseen expenses. A certain fixed sum is deposited at regular intervals in this account. The
accumulated deposits over time along with interest can be used for payment of medical expenses,
hospital charges, etc.

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c. Home Construction deposit Scheme/Saving Account: This is also a type of recurring

deposit account in which money can be deposited regularly either for the purchase or
construction of a flat or house in future. The rate of interest offered on the deposit in this case is
relatively higher than in other recurring deposit accounts.

2.2 Bank’s rights and duties to depositors

Under the contract established in deposits acceptance by a bank, it implies the bank’s right and
duties to depositors:
 
1. To charge fee and commission: Bank has the right to impose fees and charges
onto the deposits based on the notifications made to customers from time to time.
Among the fees charged is current account annual fee, passbook replacement fee
and ATM fee. Charges are normally made onto certain transactions or as penalty,
such as charges on cheque cashing and penalty charges on returned cheque due to
insufficient fund.

2. To receive money for the customer’s account: The bank is obliged to accept
deposits on behalf of customers and duly credited into customers’ account.

3. To honour the customer’s cheque and payment instruction: The bank is

obliged to honour and pay accordingly the customers’ cheques or any other
payment instructions that have been made in accordance to mandate given to
banks.

4. To maintain confidentiality of customer’s information: The bank must protect

the customers’ information as strictly private and confidential. Certain particular

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information can only be given to authorized body upon formal request made or on
judicial cases.

5. To render a statement of account: The bank shall issue monthly statements to

customers as a record on transactions performed onto the accounts for that
particular period.

6. To abide by any mandate given by customers: The operations of the accounts

must be made according to the rules and regulations governing the account and
the mandate given by customers. Failure to comply with customers’ mandate shall
expose the banks to breach of contract or negligence. 

2.3 Depositors’ rights and duties to the bank 

 
1. To draw cheques: The depositors have the rights to draw cheques based on the amount
available in the accounts. The cheques must be drawn according to the mandate given to
the banks. Any change to the mandate details or cheque signatories must be notified and
duly updated with the banks before its execution.

2. To give payment instructions: The depositors are entitled to provide precise and definite
payment instructions to the banks at their choice. For example, a post-dated cheque
issued can only be accepted by the drawing bank upon the stated date. Depositors are also
allowed to request the bank to execute other kind of payment transactions such as funds
transfer and interbank GIRO.

3. To exercise reasonable care in drawing cheques: Cheques are valid bill of exchanges
when they’ve been issued accordingly and deemed correct. Therefore, current
accountholders are responsible to ensure unused cheques are kept under lock and key.
The accountholders are also responsible to exercise due care when drawing them in

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accordance to the mandate and with sufficient funds. Failure to do so, the banks shall be
rejecting the payment requests and penalize accountholders with related charges 

2.4 Cost on deposits

Deposit received by banks is a cost to the bank. Therefore, banks must put in place
proper deposits strategy (liability management) to ensure it tallies with banks overall Asset
Liability Management (ALM). ALM manages the costs within a bank to match the
corresponding income received, to achieve the targeted interest margin. The following are the
costs related to deposits:

1. Deposits maintenance cost: Deposits maintenance cost in general refers to the cost of
manpower and facilities provided by banks to facilitate all transactions performed on
deposits accounts, including the direct promotional activities and deposit retention
programmes. These costs are classified under bank’s overhead costs. The cost includes
security and insurance coverage on hard-cash.

2. Interest payout: Savings and fixed deposits accounts are interest-bearing accounts.
Therefore, for every dollar received under these accounts banks must pay the interest rate
upon maturity or periodical basis based on the promised interest rate.

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3. CONSERVATIVE RISK PROFILE INVESTORS

3.1 Risk Profile Investor
These five categories are summaries of how the investor feels about investment risk, how much
downside market fluctuations can be tolerated, and how much they expect to profit when markets
are going up. The biggest reason for needing to classify someone into a defined category is
because most investment advisors use asset allocation models that correspond directly with each
category. Once one is put into a category, an investment adviser can easily invest their money
appropriately by using the corresponding model portfolio.

1. Conservative:

Conservative investors are investors who want stability and are more concerned with protecting
their current investments than increasing the real value of their investments.

2. Moderately Conservative:

Moderately conservative investors are investors who want to protect their capital, and achieve
some real increase in the value of their investments.

3. Moderate:

Moderate investors are long-term investors who want reasonable but relatively stable growth.
Some fluctuation are tolerable, but investors want less risk than that attributable to a fully equity
based investment.

4. Moderately Aggressive:

Moderate investors are long term investors who want good real growth in their capital. A fair
amount of risk is acceptable.

5. Aggressive:

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Aggressive investors are long-term investors who want high capital growth. Substantial year-to-
year fluctuations in value are acceptable in exchange for a potentially high long-term return.

3.2 Conservative Investors

This investor isn’t willing to tolerate "noticeable downside market fluctuations," and is willing to
forego most all significant upside potential, relative to the markets, to achieve this goal. In
English, they really don't want to get their monthly statement and see less money than they had
before (unless it was due to withdrawals).

Most conservative investors want their portfolio to provide them with an inflation-adjusted
income stream to pay their living expenses. They're either currently dependent on their
investments to provide some or all of their retirement paycheck, or are expecting this to happen
soon. Some are on tight budgets and are barely making a living as it is, so they are very afraid of
losing what little money they have left. They do not have time to recoup any losses (because they
can't go back to work for a multitude of reasons). Some realize they don't need their portfolio to
provide income for more than several years, because of low life expectancy, so growth is not the
objective.

Some of the main examples for Conservative Investors is

 Housewives
 Retired Persons
 Students

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