foreign-institutional-investors-andfinal project jatinder

8/7/2019 Foreign-Institutional-Investors-Andfinal Project Jatinder

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A

ANALYSIS OF

FOREIGN INSTITUTIONAL INVESTORS AND MUTUAL FUNDS IMPACT ON

INDIAN CAPITAL MARKET

With reference to

MIN-MAX INVESTMENT ADVISORS FOUNDATION

P.VENKATA PRATAPA REDDY

(HT.No. O89-060-108)

Project submitted in partial fulfillment for the award of the degree of

MASTER OF BUSINESS ADMINISTRATION

BY

OSMANIA UNIVERSITY

HYDERABAD

2006-2008


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Name and Address of the student Signature of the student

P. VENKATA PRATAP REDDY

F.NO: 3

D.NO. 6-1-630/5

KAIRATHABAD

HYDERABAD.

ACKNOWLEDGEMENT

I am grateful to Mr. C.SRINIVASULA REDDY Investment Advisor of MIN- MAX INVESTMENT ADVISORS FOUNDATIONfor granting me a permission to do my

project work in their esteemed organization for giving necessary information in the

department.

I would like to convey my heartiest thanks to Mr.SIVA RAM REDDY Faculty of Finance,

VELANGINI INSTITUTE OF MANAGEMENT, for their continuous support in making

my project a successful.

I thank my family and friends for being a source of inspiration and support.

(P.VENKATA PRATAPA REDDY)

TABLE OF CONTENTS

APTER NO. NAME OF THE CONTENTS GE NO.

LIST OF TABLE I.

quity Investment 73


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l funds 76

omparison 79

LIST OF FIGURES II

HAPTER 4.1 et 59

4.2 t 60

4.3 et 61

4.4 and MF 62

4.5 IS and MF 64

4.6 losing 65

4.7 e of FIIS 66

4.8 e of MF 67

4.9 e of Nifty 68


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TABLE OF CONTENTS

apter No. NAME OF THE CONTENTS ge No.

LIST OF TABLE I.

LIST OF FIGURES II.

1.

INTRODUCTION

e to FIIs and Mutual Funds impact on Indian Capital

ts

1

ives

of data

tions 4

dology 5

2.

REVIEW OF LITERATURE

ew of Financial Markets 9

of FIIs and Mutual Fund 18

3.

THE COMPANY

ny profile 53

4.ATA ANALYSIS AND PRESENTATION

tation and analysis 56

5.

UMMARY AND CONCLUSIONS

gs 69

tions 70

sions 71

BIBLIOGRAPHY 72

APPENDICES 73


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PREFACE TO FOREIGN INSTITUTIONAL INVESTORS AND MUTUAL FUNDS

FOREIGN INSTITUTIONAL INVESTORS

FIIs have been allowed to invest in the Indian securities market since September 1992

when the Guidelines for Foreign Institutional Investment were issued

by the Government. The SEBI (Foreign Institutional Investors) Regulations were enforced

in November 1995, largely based on these Guidelines. The regulations

require FIIs to register with SEBI and to obtain approval from the Reserve Bank of India

(RBI) under the Foreign Exchange Regulation Act to buy and sell securities, open foreign

currency and rupee bank accounts, and to remit and repatriate funds. Once SEBI registrationhas been obtained, an FIIs does not require any further permission to buy or sell securities

or to transfer funds in and out of the country, subject to payment of applicable tax. Foreign

investors, whether registered as FIIs or not, may also invest in Indian securities outside the

country.

MUTUAL FUNDS

A mutual fund is nothing more than a collection of stocks and/or bonds. You can think of a

mutual fund as a company that brings together a group of people and invests their money in

stocks, bonds, and other securities. Each investor owns shares, which represent a portion of

the holdings of the fund.


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OBJECTIVES

1. To determine the part of foreign institutional investors and mutual fund.

2.Contribution of FIIs and MFs in the growth of the Indian capital markets subjected to

benchmark index of Nifty-50 movement.

3.To study in the concept of foreign institutional investors and mutual fund.

4.To study various types of mutual funds.

SCOPE OF DATA

Data is collected related to the foreign institutional investors and mutual fund activities of

Indian capital market from the Security exchange board of India.

(SEBI) monthly report.

As data has been collected for 98 months from the year January 1999 to February 2007.


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Data of Nifty for the comparison is taken form s&p cnx Nifty fro the same period.

LIMITATIONS

1. There may be shift in foreign institutional investor from equity market to debt market.

2. Mutual fund may replace with another equity instrument which yields a high return and low

risk.

3. Foreign institutional investors & Mutual fund will have a great impact on macro economy of

the country.

4. FIIs&MFs will reduce the risk because of hedging their position in the suitable derivative

instrument i.e. Futures and Options.

5. Derivatives Investment not considered in the project.

.


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METHODOLOGY

METHODS OF DATA COLLECTION

In this project two types of data is utilized i.e.,

1. Primary Data

2. Secondary Data

PRIMARY DATA: is collected from the live terminal of Min - Max Investment AdvisoryFoundations.

SECONDARY DATA: Secondary data has been taken from NSEindia.com and Money

control.com from Internet depending upon required information


FIIs data has been collected from January 1999 to 2007.


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The investment of FIIs taken as Gross Purchases, Gross Sales for the above years in month

wise.

From the Gross Purchases and Gross Sales we derived the Net Investment of FIIs in Indian

Market.

Net Investment = Gross Purchases Gross Sales

If the gross purchase is higher than gross sales in particular month, it indicates FIIs are

pored money in Indian markets as investment, and vice-versa indicates disinvesting their

portfolio as aggregate.

Cumulative investment has been taken for calculating the rate of change..

% Change = Gross Purchases Gross Sales x 100

Gross Purchases

Monthly wise FIIs contribution is calculated by taking whole FIIs investment as 100%.


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MUTUAL FUNDS

MFs data has been collected from January 2000 to 2007.

The investment of MFs taken as Gross Purchases, Gross Sales for the above years in month

wise.

From the Gross Purchases and Gross Sales we derived the Net Investment of MFs in Indian

Market.

Net Investment = Gross Purchases Gross Sales

If the gross purchase is higher than gross sales in particular month, it indicates MFs are

pored money in Indian markets as investment, and vice-versa indicates disinvesting their

portfolio as aggregate.

Cumulative investment has been taken for calculating the rate of change..

% Change = Gross Purchases Gross Sales x 100Gross Purchases

Monthly wise MF's contribution is calculated by taking whole MFs investment as 100%.

NET OF FIIS AND MFS

Addition of MF and FII investment indicates the net flow of money in the markets during

the same period.

NIFTY

The opening and closing data has been collected for NSE Nifty, from the years 1999 to

2007.

Net change in NIFTY = Nifty closing Nifty Opening

From the Net has calculated the % Change

% Change = NIFTY Closing Nifty Opening x100

Nifty Opening

It indicates the nifty movement in that particular month.

In general if the opening is less than the closing of index which gives positive number that

indicates markets are in northward direction and vice versa indicates southward direction.


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OVERVIEW OF FINANCIAL MARKETS

IntroductionThere are 22 stock exchanges in India, the first being the Bombay Stock Exchange (BSE),

which began formal trading in 1875, making it one of the oldest in Asia. Over the last few

years, there has been a rapid change in the Indian securities market, especially in the

secondary market. Advanced technology and online-based transactions have modernized the

stock exchanges. In terms of the number of companies listed and total market capitalization,

the Indian equity market is considered large relative to the countrys stage of economic

development. The number of listed companies increased from 5,968 in March 1990 to about

10,000 by May 1998 and market capitalization has grown almost 11 times during the sameperiod.

The debt market, however, is almost nonexistent in India even though there has been a large

volume of Government bonds traded. Banks and financial institutions have been holding a

substantial part of these bonds as statutory liquidity requirement.

The portfolio restrictions on financial institutions statutory liquidity requirement are still in

place. A primary auction market for Government securities has been created and a primary

dealer system was introduced in 1995. There are six authorized primary dealers. Currently,

there are 31 mutual funds, out of which 21 are in the private sector. Mutual funds were

opened to the private sector in 1992. Earlier, in 1987, banks were allowed to enter this

business, breaking the monopoly of the Unit Trust of India (UTI), which maintains a

dominant position.

Before 1992, many factors obstructed the expansion of equity trading. Fresh capital issues

were controlled through the Capital Issues Control Act. Trading practices were not

transparent, and there was a large amount of insider trading. Recognizing the importance of

increasing investor protection, several measures were enacted to improve the fairness of the

capital market. The Securities and Exchange Board of India (SEBI) was established in 1988.

Despite the rules it set, problems continued to exist, including those relating to disclosure

criteria, lack of Brokers, capital adequacy, and poor regulation of merchant bankers and

underwriters. There have been significant reforms in the regulation of the securities market

since 1992 in conjunction with overall economic and financial reforms. In 1992, the SEBI


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Act was enacted giving SEBI statutory status as an apex regulatory body. And a series of

reforms was introduced to improve investor protection, automation of stock trading,

integration of national markets, and efficiency of market operations. India has seen a

tremendous change in the secondary market for equity. Its equity market will most likely be

comparable with the worlds most advanced secondary markets within a year or two. The

key ingredients that underlie market quality in Indias equity market are:

Exchanges based on open electronic limit order book

Nationwide integrated market with a large number of informed traders and

fluency of short or long positions; and

No counterparty risk.

Among the processes that have already started and are soon to be fully implemented are

electronic settlement trade and exchange-traded derivatives.Before 1995, markets in India used open outcry, a trading process in which traders shouted

and hand signaled from within a pit. One major policy initiated by SEBI from 1993 involved

the shift of all exchanges to screen-based trading, motivated primarily by the need for

greater transparency. The first exchange to be based on an open electronic limit order book

was the National Stock Exchange (NSE), which started trading debt instruments in June

1994 and equity in November 1994. In March 1995, BSE shifted from open outcry to a limit

order book market. Currently, 17 of Indias stock exchanges have adopted open electronic

limit order. Before 1994, Indias stock markets were dominated by BSE in other parts of the

country.

RECENT DEVELOPMENTS AND POLICY ISSUES.

Financial industry did not have equal access to markets and was unable to participate in

forming prices, compared with market participants in Mumbai (Bombay). As a result, the

prices in markets outside Mumbai were often different from prices in Mumbai. These

pricing errors limited order flow to these markets.

Explicit nationwide connectivity and implicit movement toward one national market has

changed this situation. NSE has established satellite communications which give all trading

members of NSE equal access to the market. Similarly, BSE and the Delhi Stock Exchange

are both expanding the number of trading terminals located all over the country. The

arbitrages are eliminating pricing discrepancies between markets.


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The Indian capital market still faces many challenges if it is to promote more efficient

allocation and mobilization of capital in the economy.

Firstly, market infrastructure has to be improved as it hinders the efficient flow of

information and effective corporate governance. Accounting standards will have to adapt to

internationally accept accounting practices. The court system and legal mechanism should

be enhanced to better protect small shareholders rights and their capacity to monitor

corporate activities.

Secondly, the trading system has to be made more transparent. Market information is a

crucial public good that should be disclosed or made available to all participants to achieve

market efficiency. SEBI should also monitor more closely cases of insider trading.

Thirdly, India may need further integration of the national capital market through

consolidation of stock exchanges. The trend all over the world is to consolidate and mergeexisting stock exchanges. Not all of Indias 22 stock exchanges may be able to justify their

existence. There is a pressing need to develop a uniform settlement cycle and common

clearing system that will bring an end to unnecessary speculation based on arbitrage

opportunities.

Fourthly, the payment system has to be improved to better link the banking and securities

industries. Indias banking system has yet to come up with good electronic funds transfer

(EFT) solutions. EFT is important for problems such as direct payments of dividends

through bank accounts, eliminating counterparty risk, and facilitating foreign institutional

investment. The capital market cannot thrive alone; it has to be integrated with the other

segments of the financial system. The global trend is for the elimination of the traditional

wall between banks and the securities market. Securities market development has to be

supported by overall macroeconomic and financial sector environments. Further

liberalization of interest rates, reduced fiscal deficits, fully market-based issuance of

Government securities and a more competitive banking sector will help in the development

of a sounder and a more efficient capital market in India. Capital Market Reforms and

Developments Reforms in the Capital Market Over the last few years, SEBI has announced

several far-reaching reforms to promote the capital market and protect investor interests.

Reforms in the secondary market have focused on three main areas:

Structure and functioning of stock exchanges, automation of trading and post trade

systems, and the introduction of surveillance and monitoring systems. Computerized online


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trading of securities, and setting up of clearing houses or settlement guarantee funds were

made compulsory for stock exchanges. Stock exchanges were permitted to expand their

trading to locations outside their jurisdiction through computer terminals. Thus, major stock

exchanges in India have started locating computer terminals in far-flung areas, while smaller

regional exchanges are planning to consolidate by using centralized trading under a

federated structure.

Online trading systems have been introduced in almost all stock exchanges. Trading is much

more transparent and quicker than in the past. Until the early 1990s, the trading and

settlement infrastructure of the Indian capital market was poor. Trading on all stock

exchanges was through open outcry, settlement systems were paper-based, and market

intermediaries were largely unregulated. The regulatory structure was fragmented and there

was neither comprehensive registration nor an apex body of regulation of the securitiesmarket. Stock exchanges were run as brokers clubs as their management was largely

composed of brokers. There was no prohibition on insider trading, or fraudulent and unfair

trade practices. Since 1992, there has been intensified market reform, resulting in a big

improvement in securities trading, especially in the secondary market for equity. Most stock

exchanges have introduced online trading and set up clearing houses/corporations. A

depository has become operational for scrip less trading and the regulatory structure has

been overhauled with most of the powers for regulating the capital market vested with

SEBI. The Indian capital market has experienced a process of structural transformation with

operations conducted to standards equivalent to those in the developed markets. It was

opened up for investment by foreign institutional investors (FIIs) in 1992 and Indian

companies were allowed to raise resources abroad through Global Depository Receipts

(GDRs) and Foreign Currency Convertible Bonds (FCCBs). The primary and secondary

segments of the capital market expanded rapidly, with greater institutionalization and wider

participation of individual investors accompanying this growth. However, many problems,

including lack of confidence in stock investments, institutional overlaps, and other

governance issues, remain as obstacles to the improvement of Indian capital market

efficiency.

PRIMARY MARKET


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Since 1991/92, the primary market has grown fast as a result of the removal of investment

restrictions in the overall economy and a repeal of the restrictions imposed by the Capital

Issues Control Act. In 1991/92, Rs62.15 billion was raised in the primary market. This

figure rose to Rs276.21 billion in 1994/95. Since 1995/1996, however, smaller amounts

have been raised due to the overall downtrend in the market and tighter entry barriers

introduced by SEBI for investor protection. SEBI has taken several measures to improve the

integrity of the secondary market. Legislative and regulatory changes have facilitated the

corporatization of stockbrokers. Capital adequacy norms have been prescribed and are being

enforced. A mark-to-market margin and intraday trading limit have also been imposed.

Further, the stock exchanges have put in place circuit breakers, which are applied in times of

excessive volatility. The disclosure of short sales and long purchases is now required at the

end of the day to reduce price volatility and further enhance the integrity of the secondarymarket.

MARK-TO-MARKET MARGIN AND INTRADAY LIMIT

Under the current clearing and settlement system, if an Indian investor buys and

subsequently sells the same number of shares of stock during a settlement period, or sells

and subsequently buys, it is not necessary to take or deliver the shares. The difference

between the selling and buying prices can be paid or received. In other words, the squaring-

off of the trading position during the same settlement period results in non-delivery of the

shares that the investor traded.

Thus, possible at a relatively low cost. FIIs and domestic institutional investors are,

however, not permitted to trade without delivery, since no delivery transactions are limited

only to individual investors. One of SEBIs primary concerns is the risk of settlement chaos

that may be caused by an increasing number of non-delivery transactions as the stock

market becomes excessively speculative.

Accordingly, SEBI has introduced a daily mark-to-market margin and intraday trading

limit. The daily mark-to-market margin is a margin on a brokers daily position. The

intraday trading limit is the limit to a brokers intraday trading volume. Every broker is

subject to these requirements.

Each stock exchange may take any other measures to ensure the safety of the market. BSE

and NSE impose on members a more stringent daily margin, including one based on

concentration of business. A daily mark-to-market margin is 100 percent of the notional loss


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of the stockbroker for every stock, calculated as the difference between buying or selling

price and the closing price of that stock at the end of that day. However, there is a threshold

limit of 25 percent of the base minimum capital plus additional capital kept with the stock

exchange or Rs1 million, whichever is lower. Until the notional loss exceeds the threshold

limit, the margin is not payable.

This margin is payable by a stockbroker to the stock exchange in cash or as a bank

guarantee from a scheduled commercial bank, on a net basis. It will be released on the pay-

in day for the settlement period. The margin money is held by the exchange for 6-12 days.

This cost the broker about 0.4-1.2 percent of the notional loss, assuming that the brokers

funding cost is about 24-36 percent.

Thus, speculative trading without the delivery of shares is no longer cost-free. Each brokers

trading volume during a day is not allowed to exceed the intraday trading limit. This limit is33.3 times the base minimum capital deposited with the exchange on a gross basis, i.e.,

purchase plus sale. In the event of brokers wishing to exceed this limit, they have to deposit

additional capital with the exchange and this cannot be withdrawn for six months.


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THEORY OF FIIS AND MFS


INTRODUCTIONFIIs have been allowed to invest in the Indian securities market since September 1992

when the Government issued the Guidelines for Foreign Institutional Investment. The SEBI

(Foreign Institutional Investors) Regulations were enforced in November 1995, largely

based on these Guidelines. The regulations require FIIs to register with SEBI and to obtain

approval from the Reserve Bank of India (RBI) under the Foreign Exchange Regulation Act

to buy and sell securities, open foreign currency and rupee bank accounts, and to remit and

repatriate funds. Once SEBI registration has been obtained, an FIIs does not require any

further permission to buy or sell securities or to transfer funds in and out of the country,subject to payment of applicable tax. Foreign investors, whether registered as FIIs or not,

may also invest in Indian securities outside the country.

Every year since FIIs were allowed to participate in the Indian market, FIIs net inflows

into India have been positive, except for 1998-99. This reflects the strong economic

fundamentals of the country, as well as the confidence of the foreign investors in the growth

with stability of the Indian market. The year 2003 marked a watershed in FIIs investment in

India. FIIs started the year 2003 in a big way by investing Rs. 985 crs in January itself.

Meanwhile, corporate India continued to report good operational results. This, along with

good macroeconomic fundamentals, growing industrial and service sectors led FIIs to

perceive great.

RBI data generally shows that investment by FIIs has been smaller, when compared with

SEBI data. This discrepancy in the statistical system needs to be corrected. One possible

explanation may involve differences in the treatment of reinvestment of profit earned.

Potential for investment in the Indian economy. In April 2003, prices of commodities like

steel and aluminum went up, propelling FII investment in May 2003 to Rs. 3,060 crore.

Around the same time, Morgan Stanley Capital International (MSCI) in its MSCI Emerging

Markets Index gave a weight of 4.3 per cent to India among the emerging markets of the

world Calendar year 2004 ended with net FII inflows of US$9.2 billion, an all-time high

since the liberalization.


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Apart from the cash market, the FIIs have been permitted by the SEBI and the RBI to trade

also in the derivatives markets. For the purpose of risk management, the FIIs are treated as

trading members in derivatives and are subjected to the same risk management measures as

any other trading member. For index options and index futures, per exchange, there is a

position limit for FIIs at the maximum of 15 per cent of the open interest of the respective

derivative contracts on a particular underlying index or Rs. 250 crore (Annex II). In

addition, they are allowed to invest more, if it is for hedging backed by securities. In case of

stocks, the FIIs position limit is the maximum of 20 per cent of the market-wide limit (if

the market-wide position limit is less than or equal to Rs. 250 crore) or Rs 50 crore (for

stocks in which the market-wide position limit is greater than Rs. 250 crore).

The most popular derivative product in India is single stock futures which account for

almost 67 per cent of the derivative contracts, followed by index futures accounting fornearly 30 per cent, and stock options and index options accounting for the rest. The retail

investors and proprietary trading account for very high proportion of trading in derivatives

market. The FIIs, on an average, account for 5.1 per cent of the monthly turnover in the

derivatives market. However, the FIIs account for around 25percent of the cumulative open

positions in single stock futures. FIIs seem to have been following a hedging strategy with

simultaneous investments in cash and derivatives market.

The diversity of FIIs has been increasing with the number of registered FIIs in India

steadily rising over the years. In 2004-05, with 145 new FIIs registering with Securities and

Exchange Board of India (SEBI), as on March 31, 2005, there was 685 FIIs registered in

India. The names of some prominent FIIs registered during 2004-05 are: California Public

Employees Retirement System (CALPERS), United Nations for and on behalf of the

United Nations Joint Staff Pension Fund, Public School Retirement System of Missouri,

Commonwealth of Massachusetts Pension Reserves Investment Trust, Treasurer of the State

North Carolina Equity Investment Fund Pooled Trust, the Growth Fund of America, and

AIM Funds Management Inc.

In terms of country of origin, the USA topped the list with a share of 40 per cent of the

number of FIIs registered in India, followed by UKs 17 per cent. Other countries of

significance in terms of origin of FIIs investing in India are Luxemburg, Hong Kong, and

Singapore. In terms of net cumulative investments by FIIs, US-based FIIs dominate with

29 per cent of the net cumulative FII investments in India, followed by UK at 17 per cent. In


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recent months, European and Japanese FIIs have started to evince an increasing interest in

India, and of the FIIs that registered with SEBI in October 2004, a significant number

belonged to Europe and Japan. These developments have helped improve the diversity of

the set of FIIs operating in India.

After the launch of the reforms in the early 1990s, there was a gradual shift towards capital

account convertibility. From September 14, 1992, with suitable restrictions, FIIs and

Overseas Corporate Bodies (OCBs) were permitted to invest in financial instruments. The

policy framework for permitting FII investment was provided under the Government of

India guidelines vide Press Note dated September 14, 1992, which enjoined upon FIIs to

obtain an initial registration with SEBI and also RBIs general permission under FERA.

Both SEBIs registration and RBIs general permissions under FERA were to hold good for

five years and were to be renewed after that period. RBIs general permission under FERAcould enable the registered FII to buy, sell and realize capital gains on investments made

through initial corpus remitted to India, to invest on all recognized stock exchanges through

a designated bank branch, and to appoint domestic custodians for custody of investments

held. The Government guidelines of 1992 also provided for eligibility conditions for

registration, such as track record, professional competence, financial soundness and other

relevant criteria, including registration with a regulatory organization in the home country.

The guidelines were suitably incorporated under the SEBI (FIIs) Regulations, 1995. These

regulations continue to maintain the link with the government guidelines by inserting a

clause to indicate that the investment by FIIs shall also An OCB is a company, partnership

firm, society and other corporate body owned directly or indirectly to the extent of at least

sixty per cent by NRIs and includes overseas trust in which not less than sixty per cent

beneficial interest is held by NRIs directly or indirectly but irrevocably. Be subject to

Government guidelines. This linkage has allowed the Government to indicate various

investment limits including in specific sectors.

Currently, entities eligible to invest under FII route are as follows:

(i) AS FIIS:

Overseas pension funds, mutual funds, investment trust, asset management company,

nominee company, bank, institutional portfolio manager, university funds, endowments,

foundations, charitable trusts, charitable societies, a trustee or power of attorney holder

incorporated or established outside India proposing to make proprietary investments or


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investments on behalf of a broad-based fund (i.e., fund having more than 20 investors with

no single investor holding more than 10 per cent of the shares or units of the fund).

(ii) AS SUB-ACCOUNTS:

The sub account is generally the underlying fund on whose behalf the FII invests. The

following entities are eligible to be registered as sub-accounts, viz. partnership firms, private

company, public company, pension fund, investment trust, and individuals.

(iii) DOMESTIC ENTITY:A domestic portfolio manager or a domestic asset management company shall also be

eligible to be registered as FII to manage the funds of sub-accounts.

FIIs registered with SEBI fall under the following categories:

(a) Regular FIIs Those who are required to invest not less than 70 per cent of their

investment in equity -related instruments and up to 30 per cent in non-equity instruments.

(b) 100 per cent debt-fund FIIs those who are permitted to invest only in debt

instruments.

The Government guidelines for FII of 1992 allowed, inter-alia, entities such as asset

management companies, nominee companies and incorporated/institutional portfolio

managers or their power of attorney holders (providing discretionary and non-discretionary

portfolio management services) to be registered as FIIs. While the guidelines did not have a

specific provision regarding clients, in the application form the details of clients on whose

behalf investments were being made were sought. While granting registration to the FII,

permission was also granted for making investments in the names of such clients. Asset

management companies/portfolio managers are basically in the business of managing funds

and investing them on behalf of their funds/clients. Hence, the intention of the guidelines

was to allow these categories of investors to invest funds in India on behalf of their clients.

These clients' later came to be Known as sub-accounts. The broad strategy consisted of

having a wide variety of clients, including individuals, intermediated through institutional

investors, who would be registered as FIIs in India. A Working Group for Streamlining of


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the Procedures relating to FIIs, constituted in April, 2003, inter alias, recommended

streamlining of SEBI registration procedure, and suggested that dual approval process of

SEBI and RBI be changed to a single approval process of SEBI. This Recommendation was

implemented in December 2003.

PARTICIPATORY NOTES (PNS)

Participatory notes (PNs) are instruments used by foreign funds, not registered in the

country, for trading in the domestic market. They are a derivative instrument issued against

an underlying security, which permits the holder to share in the capital appreciation/income

from the underlying security. PNs are like contract notes and are issued by FIIs, registered

in the country, to their overseas clients who may not be eligible to invest in the Indian stock

markets. PNs are used as an alternative to sub-accounts by ultimate investors generally

based on considerations related to transactions costs and recordkeeping overheads.FIIs invest funds on behalf of such investors, who prefer to avoid making disclosures

required by various regulators. The associates of these FIIS generally issue these notes

overseas.

The investors, who buy these notes, deposit their funds in the US or European operations of

the FII, which also operates in India. The FII then buys stocks in the domestic market on

behalf of these investors on their proprietary account. In this case, the FII or the broker acts

like an exchange: it executes the trade and uses its internal accounts to settle the trade. This

helps keeping the investor's name anonymous. Other such instruments include equity -linked

notes, capped return note, participatory return notes and investment notes.

FIIs were initially allowed to only invest in listed securities of companies. Gradually, they

were allowed to invest in unlisted securities, rated government securities, commercial paper

and derivatives traded on a recognised stock exchange. From November 1996, any

registered FII willing to make 100 per cent investment in debt securities were permitted to

do so subject to specific approval from SEBI as a separate category of FIIs or sub-accounts

as 100 per cent debt funds. The overall cap on investments in Government securities, both

through the normal route and the 100 per cent debt fund route, was revised from US$1

billion to US$1.75 billion in November, 2004. Moreover, investments were allowed only in

debt securities of companies listed or to be listed in stock exchanges. Investments were free

from maturity limitations. From April 1998, FII investments were also allowed in dated


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Government securities. Treasury bills, being money market instruments, were originally

outside the ambit of such investments, but were included subsequently from May 1998.

Initially, FIIs were permitted to hedge their investments in debt instruments in India only

with respect to currency risk. On June 11, 1998, forward cover to FIIs on their investment

in equity was also allowed subject to the maximum of the difference in dollar terms between

the market value of investment on June 11, 1998 converted at RBI reference rate and the

market value of investment at the time of providing cover, or fresh inflows since June 11,

1998. Subsequently, in November 2002, forward cover up to a maximum of 15 per cent of

the outstanding position as on March 31, 1999 plus the increase in market value after March

31, 1999 was also permitted. With this 15 per cent limit liberalized to 100 per cent of

portfolio value, FIIs have had unrestricted access to currency hedging from January 8, 2003

onwards. In June 1998, the proposed legal basis for trading in equity derivatives coincidedwith permission for FIIs to invest in equity derivatives. With the advent of trading in equity

derivatives in June 2000, and permission albeit limited in the beginning to FIIs to

participate in this market opened up further avenues for FIIs to hedge their positions in the

spot market.

Linkages with Exchange Rate, Interest Rate and Balance of Payments Exchange rate

FIIs are attracted by returns calculated in foreign currency, say for example, in US dollars.

Thus, what is relevant is the return on their investment in rupee terms and the movement of

the exchange rate of the rupee. A high rupee return on equities can be neutralized, at least in

part, by a depreciation of the rupee. For example, a 15 per cent rupee return on equities with

a 7 per cent depreciation of the rupee results in an effective dollar rate of return of about 8

per cent only. Similarly, a relatively unattractive low rupee rate of return on equities can

become attractive in dollar terms if the rupee appreciates vise -avis the dollar. Given

everything else, FII flows go up (down) when there are expectations of domestic currency

appreciation (depreciation).

INTEREST RATE

FIIs investment in debt instruments depends on the relativity of the domestic interest rate

vis--vis the world rate, adjusted for the exchange rate movement. Many developing

countries, Bose and Condo (2004), Including India, have high nominal interest rates

compared to developed countries. For example, in India, the rate of interest on 10-year

Central Government bonds was 7.15 per cent on October 3, 2005, when the corresponding


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rate on 10-year gilts in the US and Japan was 4.39per cent and 1.57 per cent, respectively.

The relevant differential, however, is not the difference between the nominal rates of

interest, but the exchange rate adjusted differential or uncovered interest rate parity

condition. For example, an investor can invest US$1 in the US and obtain T(1+ rUS) with

zero risk in T years, where US ris the annual yield from the US zero coupon yield curve for

T years. Alternatively, the investor can convert US$1 into Rs. E at the going exchange rate

of Rs. E per US$, invest the proceeds in India, and obtain TIN E(1+ r) in rupees with zero

risk in T years, whereIN ris the annual yield from the Indian zero coupon yield curve for

Tyears, convert it back into US$ at the expected future exchange rate. If the expected future

exchange rate indicates a higher (lower) return on investment in India, inflows (outflows) of

debt capital can be expected to reduce (increase)IN runtil both investments yield the same

rate of return. While there are quantitative restrictions on FII investments in debtinstruments, the equity derivative market provides an alternative route for the FIIs to

benefit from the interest rate differential.

BALANCE OF PAYMENTS

Indias balance of payments has strengthened almost continuously since the crisis of 1990-

91, mainly because of a limited current account deficit more than compensated by a buoyant

capital account. The external sector responded well to the liberalization of trade and current

account, removal of quantitative restrictions and a steady reduction in customs duty rates

from a peak rate of over 300 per cent in 1990-91 to 20 per cent in 2004-05. The current

account deficit as a proportion of GDP, after a high of 3.1 per cent in 1990-91, remained

contained Below 1.8 per cent of GDP until 2000-01, and actually turned into a surplus from

2001-02. The strength of the capital account, on the other hand, reflected the success of a

cautious approach to liberalization with an opening up of the economy to FDI and FIIs, and

restricting debt flows. FIIs flows have made an important contribution to the balance of

payments.

FII inflows contributed US$ 40.33 billion between 1992-93 and September, 2005 to the

balance of payments. This corresponds to 28.3 per cent of the foreign exchange reserves of

US$ 143.1 billion at end-September 2005. In cumulative terms, between 1992 and

December 2004,


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FII investment has been 1.06 times FDI inflows of US$ 34.5 billion. In 2004-05, gross

portfolio flows amounted to as much as 1.48 per cent of GDP and was 1.85 times gross FDI

inflows of US$ 5.54 billion.

FII VERSUS FDI

According to the International Monetary Funds Balance of Payments Manual 5, FDI is that

category of international investment that reflects the objective of obtaining a lasting interest

by a resident entity in one economy in an enterprise resident in another economy. The

lasting interest implies the existence of a long-term relationship between the direct investor

and the enterprise and a significant degree of influence by the investor in the management ofthe enterprise. According to EU law, foreign investment is labeled direct investment when

the investor buys more than 10 per cent of the investment target, and portfolio investment

when the acquired stake is less than 10 per cent. Institutional investors on the other hand are

specialized financial intermediaries managing savings collectively on behalf of investors,

especially small investors, towards specific objectives in terms of risk, returns, and maturity

of claims.

While permitting foreign firms/high net worth individuals in February, 2000 to invest

through SEBI registered FII/domestic fund managers, it was noted that there was a clear

distinction between portfolio investment and FDI. The basic presumption is that FIIs are

not interested in management control. To allay fears of management control being exercised

by portfolio investors, it was noted that adequate safety nets were in force, for example,

(i) transaction of business in securities on the stock exchanges are only through stock brokers

who have been granted a certificate by SEBI,

(ii) every transaction is settled through a custodian who is under obligation to report to SEBI

and RBI for all transactions on a daily basis,

(iii) Provisions of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.

(iv) Monitoring of sectoral caps by RBI on a daily basis.

VOLATILITY THROUGH OUTFLOWS

After the Asian crisis of 1997, the problem of volatility has been a matter of much

Discussion. In fact, Malaysia imposed severe capital controls on October 1, 1998 to that the


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perceived destabilizing actions of foreign speculators. FII inflows are popularly described as

hot money, because of the herding behavior and potential for large capital outflows.

Herding behavior, with all the FIIs trying to either only buy or only sell at the same time,

particularly at times of market stress, can be rational. With performance-related fees for

fund managers, and performance judged on the basis of how other funds are doing, there is

great incentive to suffer the consequences of being wrong when everyone is wrong, rather

than taking the risk of being wrong when some others are right. The incentive structure

highlights the danger of a contraries bet going wrong and makes it much more severe than

performing badly along with most others in the market. It not only leads to reliance on the

same information as others but also reduces the planning horizon to a relatively short one.

Value at Risk models followed by FIIs may destabilize markets by leading to simultaneous

sale by various FIIs, as observed in Russia and Long Term Capital Management 1998(LTCM) crisis. Extrapolative expectations or trend chasing rather than focusing on

fundamentals can lead to destabilization portfolios.

VOLATILITY THROUGH INFLOWS

Traditionally, developing countries plagued by problems of financing the deficits in the

balance of payments have been wary of FIIs because of the potential for large capital

outflows generated by their herding behavior. However, of late, some developing countries

like China and India have also had a problem of sizeable surpluses on the balance of

payments leading to upward pressure on the exchange rate or on domestic prices through

excessive liquidity creation.

FOREIGNERS CAPTURING MARKETS

The fear of foreigners capturing the securities markets has genuine content only if such

foreigners act as in cahoots to destabilize the economy. Otherwise, fear of foreigners per

reargues in favor of banning not only FIIs but FDIs and imports of merchandise as well.

DAY TRADING

Section 43(5) of the Income Tax Act defines speculative transaction to mean a

Transaction in which a contract for the purchase or sale of any commodity, including stocks

and shares, is periodically or ultimately settled or otherwise than by actual delivery or

transfer of the commodity or scrips. Day -trading, wherein purchases made earlier in the

day are sold for a profit or loss within the day itself, without taking delivery, is speculative

according to the Income Tax Act, 1961. By the criterion of classifying investment as long-


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term or speculative on the bas is of time horizons, day -trading qualifies as a speculative

investment. It may be noted that the FIIs being required to transact on the basis of giving

and taking deliveries, are prohibited from day trading. Hence, FIIs are barred from this

extreme form of speculative activity.

ROLE OF SPECULATION

Bekaert and Harvey (2000): Throughout history and in many market economies, the

speculator has been characterized as both a villain and a savior. Indeed, the reputation of the

speculator generally depends on the country where he does business. In well-functioning

advanced capital markets, such as the United States, the speculator is viewed as an integral

part of the free-market system. In developing capital markets, the speculator, and in

particular the international speculator, is looked upon with many reservations.

HEDGE FUNDSIn the last three years, there has been considerable interest in the regulatory questions

associated with the participation by foreign hedge funds in the Indian equity market.

What are Hedge funds?

Hedge funds, which are private investment vehicles for wealthy individuals or institutional

investors, have been in existence for over half a century. They, however have little to do

with hedging or eliminating risks arising from an underlying portfolio position. Hedge funds

constitute an alternative to mutual funds in terms of being a vehicle for fund management.

Regulation of mutual funds, motivated by the need to protect small investors, induces

significant costs of regulation. Hedge funds are prevented from accessing small investors,

and are free from this regulation. They are able to engage in a wider array of trading

strategies, and contractual structures, as compared with mutual funds. They are the preserve

of sophisticated investors who are able to take care of their own interests, and not rely on an

intrusive regulatory framework designed at protecting small investors. If the costs of

regulation of mutual funds are substantial, hedge funds would yield superior returns.

POLICY OPTIONS

Benefits and costs of FII investments

The terms of reference asking the Expert Group to consider how FII inflows can be

encouraged and examine the adequacy of the existing regulatory.


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Frameworks to adequately address the concern for reducing vulnerability to the flow of

speculative capital do not include an examination of the desirability of encouraging FII

inflows. Yet, for motivating the consideration of the policy options, it is useful to briefly

summarize the benefits and costs for India of having FII investment. Given the Groups

mandate of encouraging FII flows, the available arguments that mitigate the costs have also

been included under the relevant points.

BENEFITS

Reduced cost of equity capitalFII inflows augment the sources of funds in the Indian capital markets. In a common sense

way, the impact of FIIs upon the cost of equity capital may be visualized by asking what

stock prices would be if there were no FIIs operating in India. FII investment reduces the

required rate of return for equity, enhances stock prices, and fosters investment by Indian

firms in the country.

Imparting stability to India's Balance of Payments

For promoting growth in a developing country such as India, there is need to augment

domestic investment, over and beyond domestic saving, through capital flows. The excess

of domestic investment over domestic savings result in a current account deficit and this

deficit is financed by capital flows in the balance of payments. Prior to 1991, debt flows and

official development assistance dominated these capital flows. This mechanism of funding

the current account deficit is widely believed to have played a role in the emergence of

balance of payments difficulties in 1981 and 1991. Portfolio flows in the equity markets,

and FDI, as opposed to debt-creating flows, are important as safer and more sustainable

mechanisms for funding the current account deficit.

Knowledge flows


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The activities of international institutional investors help strengthen Indian finance. FIIs

advocate modern ideas in market design, promote innovation, development of sophisticated

products such as financial derivatives, enhance competition in financial intermediation, and

lead to spillovers of human capital by exposing Indian participants to modern financial

techniques, and international best practices and systems.

Strengthening corporate governance

Domestic institutional and individual investors, used as they are to the ongoing practices of

Indian corporate , often accept such practices, even when these do not measure up to the

international benchmarks of best practices. FIIs with their vast experience with modern

corporate governance practices are less tolerant of malpractice by corporate managers and

owners (dominant shareholder). FII participation in domestic capital markets often lead to

vigorous advocacy of sound corporate governance practices, improved efficiency and bettershareholder value.

Improvements to market efficiency

A significant presence of FIIs in India can improve market efficiency through two

Channels. First, when adverse macroeconomic news, such as a bad monsoon, unsettles

many domestic investors, it may be easier for a globally diversified portfolio manager to be

more dispassionate about India's prospects, and engage in stabilizing trades. Second, at the

level of individual stocks and industries, FIIs may act as a channel through which

knowledge and ideas about valuation of a firm or an industry can more rapidly propagate

into India. For example, foreign investors were rapidly able to assess the potential of firms

like Infosys, which are Primarily export-oriented, applying valuation principles that

prevailed outside India for software services companies.

Costs

Herding and positive feedback trading


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MUTUAL FUNDSINTRODUCTION

Indian investors have been able to invest through mutual funds since 1964, when UTI was

established. Indian mutual funds have been organized through the Indian Trust Acts, under

which they have enjoyed certain tax benefits. Between 1987 and 1992, public sector banks

and insurance companies set up mutual funds. Since 1993, private sector mutual funds have

been allowed, which brought competition to the mutual fund industry. This has resulted in

the introduction of new products and improvement of services. The notification of the SEBI

(Mutual Fund) Regulations of 1993 brought about a restructuring of the mutual fund

industry. An arms length relationship is required between the fund sponsor, trustees,

custodian, and Asset Management Company. This is in contrast to the previous practice

where all three functions, namely trusteeship, custodianship, and asset management, were

often performed by one body, usually the fund sponsor or its subsidiary. The regulations

prescribed disclosure and advertisement norms for mutual funds, and, for the first time,

permitted the entry of private sector mutual funds. FIIs registered with SEBI may invest in

domestic mutual funds, whether listed or unlisted. The 1993 Regulations have been revised

on the basis of the recommendations of the Mutual Funds 2000 Report prepared by SEBI.

The revised regulations strongly emphasize the governance of mutual funds and increase the

responsibility of the trustees in overseeing the functions of the asset management company.

Mutual funds are now required to obtain the consent of investors for any change in the

fundamental attributes of a scheme, on the basis of which unit holders have invested. The


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revised regulations require disclosures in terms of portfolio composition, transactions by

schemes of mutual funds with sponsors or affiliates of sponsors, with the Asset Management

Company and trustees, and also with respect to personal transactions of key personnel of

asset management companies and of trustees.

Mutual Funds have become extremely popular over the last 20 years. What was once just

another obscure financial instrument is now a part of our daily lives. More than 80 million

people, or one half of the households in America, invest in mutual funds. That means that, in

the United States alone, trillions of dollars are invested in Mutual Fund. In fact, too many

people, investing means buying mutual funds. After all, its common knowledge that

investing in mutual funds is better than simply letting your cash waste away in a savings

account, but, for most people, that's where the understanding of funds ends. It doesn't help

that mutual fund salespeople speak a strange language that is interspersed with jargon thatmany investors don't understand.

DEFINITION

A mutual fund is nothing more than a collection of stocks and/or bonds. You can think of a

mutual fund as a company that brings together a group of people and invests their money in

stocks, bonds, and other securities. Each investor owns shares, which represent a portion of

the holdings of the fund.

You can make money from a mutual fund in three ways:

1. Income is earned from Dividends on stocks and Interest on bonds. A fund pays out nearly

all of the income it receives over the year to fund owners in the form of a distribution.

2. 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.

3. 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.

ADVANTAGES OF MUTUAL FUNDS

Professional Management - The primary advantage of funds (at least theoretically) is the

professional management of your money. Investors purchase funds because they do not

have the time or the expertise to manage their own portfolios. A mutual fund is a relatively


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inexpensive way for a small investor to get a full-time manager to make and monitor

investments.

Diversification -: By owning shares in a mutual fund instead of owning individual stocks

or bonds, your risk is spread out. 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.

In other words, the more stocks and bonds you own, the less any one of them can hurt you

(think about Enron). Large mutual funds typically own hundreds of different stocks in many

different industries. It wouldn't be possible for an investor to build this kind of a portfolio

with a small amount of money.

Economies of Scale -: Because a mutual fund buys and sells large amounts of securities at a

time, its transaction costs are lower than what an individual would pay for securities

transactions.Liquidity: - Is like an individual stock, a mutual fund allows you to request that your shares

be converted into cash at any time.

Simplicity - Buying a mutual fund is easy! Pretty well any bank has its own line of mutual

funds, and the minimum investment is small. Most companies also have automatic purchase

plans whereby as little as $100 can be invested on a monthly basis.

DISADVANTAGES OF MUTUAL FUNDS:

Professional Management - Did you notice how we qualified the advantage of professional

management with the word "theoretically"? Many investors debate whether or not the so-

called professionals are any better than you or I at picking stocks. Management is by no

means infallible, and, even if the fund loses money, the manager still takes his/her cut. We'll

talk about this in detail in a later section.

Costs - Mutual funds don't exist solely to make your life easier - all funds are in it for a

profit. The mutual fund industry is masterful at burying costs under layers of jargon. These

costs are so complicated that in this tutorial we have devoted an entire section to the subject.

Dilution - It's possible to have too much diversification. Because funds have small holdings

in so many 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.


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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-gains

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.

DIFFERENT TYPES OF MUTUAL FUNDS

No matter what type of investor you are, there is bound to be a mutual fund that fits your

style. According to the last count there are more than 10,000 mutual funds in North

America! That means there are more mutual funds than stocks.

It's important to understand that each mutual fund has different risks and rewards. In

general, the higher the potential return, the higher the risk of loss. Although some funds are

less risky than others, all funds have some level of risk - it's never possible to diversify away

all risk. This is a fact for all investments.Each fund has a predetermined investment objective that tailors the fund's assets, regions of

investments and investment strategies. At the fundamental level, there are three varieties of

mutual funds:

1) Equity funds (stocks)

2) Fixed Income funds (bonds)

3) Money- Market funds

All mutual funds are variations of these three asset classes. For example, while equity funds

that invest in fast-growing companies are known as growth funds, equity funds that invest

only in companies of the same sector or region are known as specialty funds.

Let's go over the many different flavors of funds. We'll start with the safest and then work

through to the more risky.

Money Market Funds

The money market consists of short-term debt instruments, mostly Treasury Bill. This is a

safe place to park your money. You won't get great returns, but you won't have to worry

about losing your principal. A typical return is twice the amount you would earn in a regular

checking/savings account and a little less than the average certificate of deposit (CD).

Bond/Income Funds


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Income funds are named appropriately: their purpose is to provide current income on a

steady basis. When referring to mutual funds, the terms "fixed-income," "bond," and

"income" are synonymous. These terms denote funds that invest primarily in government

and corporate debt. While fund holdings may appreciate in value, the primary objective of

these funds is to provide a steady cash flow to investors. As such, the audience for these

funds consists of conservative investors and retirees.

Bond funds are likely to pay higher returns than certificates of deposit and money market

investments, but bond funds aren't without risk. Because there are many different types of

bonds, bond funds can vary dramatically depending on where they invest. For example, a

fund specializing in high-yield Junk Bonds is much more risky than a fund that invests in

government securities. Furthermore, nearly all bond funds are subject to interest rate risk,

which means that if rates go up the value of the fund goes down.

Balanced Funds

The objective of these funds is to provide a balanced mixture of safety, income and capital

appreciation. The strategy of balanced funds is to invest in a combination of fixed income

and equities. A typical balanced fund might have a weighting of 60% equity and 40% fixed

income. The weighting might also be restricted to a specified maximum or minimum for

each asset class.

A similar type of fund is known as an asset allocation fund. Objectives are similar to those

of a balanced fund, but these kinds of funds typically do not have to hold a specified

percentage of any asset class. The portfolio manager is therefore given freedom to switch

the ratio of asset classes as the economy moves through the Business cycle.

Equity Funds

Funds that invest in stocks represent the largest category of mutual funds. Generally, the

investment objective of this class of funds is long-term capital growth with some income.

There are, however, many different types of equity funds because there are many different

types of equities. A great way to understand the universe of equity funds is to use a style

box, an example of which is below.


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The i ea i t classi funds based on both the si e of the companies invested in and the

investment st le of the manager. The term value refers to a st le of investing thatlooks for

high qualit companies that are out of favor with the market. These companies are

characteri ed by low P/e and price to book ratios and high dividend yields. The opposite

of value is growth, which refers to companies that have had (and are expected to continue to

have) strong growth in earnings, sales and cash flow. A compromise between value and

growth is blend, which simply refers to companies that are neither value nor growth stocks

and are classified as being somewhere in the middle.

Gl l/ i l

An international fund (or foreign fund) invests only outside your home country. Global

funds invest anywhere around the world, including your home country.

It s tough to classify these funds as either riskier or safer than domestic investments. They

do tend to be more volatile and have unique Country and/or political risks. But, on the flip

side, they can, as part of a wellbalanced portfolio, actually reduce risk by increasing

diversification. Although the world's economies are becoming more inter-related, itis likely

that another economy somewhere is outperforming the economy of your home country.

i l

This classification of mutual funds is more of an all-encompassing category that consists of

funds that have proved to be popular but don't necessarily belong to the categories we've

described so far. This type of mutual fund forgoes broad diversification to concentrate on a

certain segment ofthe economy.


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Sector funds are targeted at specific sectors of the economy such as financial, technology,

health, etc. Sector funds are extremely volatile. There is a greater possibility of big gains,

but you have to accept that your sector may tank.

Regional funds make it easier to focus on a specific area of the world. This may mean

focusing on a region (say Latin America) or an individual country (for example, only

Brazil). An advantage of these funds is that they make it easier to buy stock in foreign

countries, which is otherwise difficult and expensive. Just like for sector funds, you have to

accept the high risk of loss, which occurs if the region goes into a bad recession.

Socially Responsible funds (or ethical funds) invest only in companies that meet the

criteria of certain guidelines or beliefs. Most socially responsible funds don't invest in

industries such as tobacco, alcoholic beverages, weapons or nuclear power. The idea is to

get a competitive performance while still maintaining a healthy conscience.Index Funds

The last but certainly not the least important are index funds. This type of mutual fund

replicates the performance of a broad market index such as the S& P 500 or Dow Jones

Industrial Average (DJIA). An investor in an index fund figures that most managers can't

beat the market. An index fund merely replicates the market return and benefits investors in

the form of low fees.

The important step is to define your financial goals and, determine the level of risk you are

comfortable with and the investment time frame. Generally, the higher the potential return,

the higher the risk of loss.

Mutual fund classification

Mutual funds can be classified on the basis ofstructure, investment objective, and payout

plans.

Structure wise, there are three basic types of mutual funds: open ended, close endedand interval funds.

Structure


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An open-ended fund is available for subscription and repurchase on a continuous basis.

Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices,

which are declared on a daily basis. Open-ended schemes do not have a fixed duration. The

key feature of open-end schemes is liquidity.

A close-ended fund does not provide the facility of subscription throughout the year; it is

open for a subscription for a fixed duration as specified in the prospectus of the fund. The

investor can apply for the units of the fund only during the initial offer period following

which units can be bought and sold only at the stock exchange, where the fund is listed, at

the market price.

An Interval funds combine the features of open-ended and close-ended schemes. They may

be traded on the stock exchange or may be open for sale or redemption during pre-

determined intervals at NAV linked prices.

Investment objective

Besides, the structure, each fund has a different investment objective.

Equity funds: Their objective is the growth of capital over the long term. Equity funds also

known as growth funds as these funds invest in equities and liquid money market securities.

They have a high risk attached as the returns from them are also spectacular. They are

suitable for investors who have a long-term investment objective and have surplus funds

after investing in basic and safe investment avenues.

Balanced funds: Balanced funds hold a combination of equity and debt investments and

cash equivalent. They have the objective of providing both regular income and moderate

growth while minimizing risk.

Sector funds: These are the funds, which invest in the securities of only those sectors orindustries as specified in the offer documents, e.g., pharmaceuticals, software, FMCG, etc.

The returns in these funds are dependent on the performance of the respective

sectors/industries. While these funds may give returns higher than even the plain or vanilla


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growth schemes, which have investments spread over different sectors, they are also more

risky

Tax saving funds: Just like insurance policies of PPF, these schemes offer tax rebates to the

investors under specific provisions of the Income Tax Act, 1961. These schemes are growth

oriented and invest pre-dominantly in equities. Thus you get the dual benefit of tax rebate on

the amount invested as well as a growth in your capital. But these schemes come with the

risks associated with equity schemes.

Index funds: They replicate the portfolio of an index such as the BSE Sensitive Index, S&P

NSE 50 index (Nifty), etc these schemes invest in securities in the same weight age as

comprising in their chosen index. NAVs of such schemes would rise or fall in accordance

with the rise or fall in the index, though not exactly by the same percentage due to "tracking

error".

Exchange traded funds: They combine the best features of open ended and close-ended

funds. They track an index and can be traded like a single stock on the stock exchange. It is

priced continually and can be bought or sold throughout the trading day.

Money market funds: These funds invest in treasury bills, call money and certificates of

deposit. The objective of these funds is to maximum protection of capital. Hence, they

provide relatively low returns. This kind of fund is appropriate for investors who want to

park funds for a short duration. These schemes are popular with institutional investors and

high net worth individuals with short-term surplus funds.

Income funds: These funds invest in corporate bonds, commercial paper, certificate of

deposit and government securities. The objectives are regular income and capital

preservation. They are moderately low-risk and are suitable for investors who need a regular

source of income.

Gilt funds: Gilt funds predominantly invest in government securities and money market

instruments. As the investments are in government paper these funds have little risk of

default and hence offer better protection of principal. The prices of government securities

are influenced by the movement in interest rates in the financial system.


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However, one must recognize the potential changes in values of debt securities held by the

funds that are caused by changes in the market price of these securities. Generally when

interest rates rise, prices of government securities fall and when interest rates drop the prices

increase.

Payout plans

Besides structure and investment objective, mutual funds can be further divided into two on

the basis of their payout plan. They are two plans available: the growth option and the

dividend option. Dividend is payable only to investors who opt for the dividend option.

After the declaration of the dividend, the NAV of the unit comes down to the extent of the

dividend declared. Investors under the growth option do not receive any dividends. Instead

dividends are reinvested, and hence the NAV shows a higher appreciation.

Performance measures for mutual funds

Risk and investing go hand in hand. To know your funds performance, apart from

comparing the performance vi-a-vis the benchmarks, an investor should also make use of

certain statistical measures that make evaluation of a mutual fund even more precise.

Among the most commonly used ratios, there are six ratios, which we come across very

often but fail to understand their utility. They are Standard Deviation, Beta, Sharpe, Alpha,

Treynor and R-Squared.

Standard deviation: Standard deviation is a statistical measure of the range of a fund's

performance, and is reported as an annual number. When a fund has a high standard

deviation, its range of performance has been very wide, indicating that there is a greater

potential for volatility.

Beta: Another way to assess the Funds up and down movement is its Beta measure. Beta

measures the volatility of a fund relative to a particular market benchmark i.e. how sensitive

the fund is to market movements.

A Beta greater than 1 means that the fund is more volatile than the benchmark. A Beta less

than 1 means that the fund is less volatile than the benchmark. For example, a Beta of 1.1


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would indicate that if the market goes up 10%, the fund might rise 11% and vice versa in a

down market.

Sharpe: The most common measure that combines both risk and reward into a single

indicator is the Sharpe Ratio. A Sharpe Ratio is computed by dividing a funds return in

excess of a risk-free return (usually a 90-day Treasury bill or SBI fixed deposit rate) by its

standard deviation. This measures the amount of return over and above a risk-free rate

against the amount of risk taken to achieve the return. So if a fund produced a 20% return

while the SBI fixed deposit rate returned 6.5% and its standard deviation is 10%, its Sharpe

Ratio would be (20 6.5) / 10 = 1.35.

Generally, there is no right or wrong Sharpe Ratio. The measure is best used to compare one

funds ratio with another, or to its peer group average. For similar funds the higher the

Sharpe Ratio, the better a funds historical risk-adjusted performance.

Sharpe ratio = (Fund Average Return - Risk Free Return) / Standard Deviation of the fund.

R-Squared (R2): The R-Squared measure reveals what percentage of a funds movements

can be related to movements in its benchmark index. An R-Squared of 100 would mean that

all of the funds movements are perfectly explained by its benchmark; Index funds normally

achieve this ideal. A high R-squared means the beta on a fund is actually a useful

measurement. A low R-squared means ignore the beta.

Alpha: The Alpha measure is less about risk than it is about "value added." Alpha

represents the difference between the performance you would expect from a fund, given its

Beta, and the actual returns it generates. A high alpha (more than 1) means that the fund has

performed well. A negative alpha means the fund under performed.

Mathematically, Alpha= fund return - [Risk free rate + Beta of fund (Benchmark return -

Risk free return)]

Treynor: the Treynor ratio is similar to the Sharpe ratio. Instead of comparing the funds

risk adjusted performance to the risk free return, it compares the funds risk adjusted

performance of the relative index.


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COMPANY PROFILE

Min-Max Investment Advisors Foundation, a professionally managed Investment

advisory services company, developed in the year 2000 by three young entrepreneurs with

an intension to Minimization of Risk and Maximization of Return in the field of Indian

Capital markets by extensive research work.

As a sub member ofNSE BSE MCX NCDEX NSDL and CDSL, which are pioneers in the

respective operations, Min-Max is having more than 500 client base with two operation

units at Hyderabad and Rajampet, Kadapa Dist.,

NSE: National Stock Exchange

BSE: Bombay Stock Exchange

MCX: Multi Commodity Exchange

NCDEX: National Commodities and Derivatives Exchange

NSDL: National Securities Depository Ltd

CDSL: Central Depository Services Ltd

Min-Max, an aggressive player in Investment Advisory, is on-par with the investor

expectations in providing professional services, namely_

Online Trading in Equity, Commodities and F&O

Framing ofDerivative strategies

Depository Services (D-MAT)

Initial Public Offers (IPO) and Book Buildings

Distribution ofMutual Funds

Portfolio Management Service (PMS) etc., through its member

Corporate training for executives on NCFM (National Stock Exchange Certificate inn

Financial Markets)

Min-Max is in market because of:

Investor care is of paramount importance at Min-Max.


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Min-Max offers large avenues of investment solutions for all classes of investors under one

roof.

Min-Max experience is one of prized possession. Min-Max has an experience of more than

7 years wherein grown phenomenally.

One of the most competitive brokerage structure.

Hassle free trading experience.

Timely advice along with research support to the clients through SMS and E-MAILS on

EQUITIES, DERIVATIVES, COMMODITIES, IPOs and Mutual Funds.

Min-Max approach:

UN BIASED INVESTMENT ADVISORY

VALUE FOR INVESTOR'S TRUST

INTEGRITY AND HONESTY

PERSONALIZED ATTENTION

RESEARCH BASED ADVISORY SERVICES

VISION:

To Become Successful Investment Advisors by developing the strategies which are

implement able and leads to provide better returns than Bench mark portfolios.


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ANALYSIS

CONTRIBUTED AMOUNT OF FOREIGN INSTITUTIONAL INVESTORS AND

MUTUAL FUNDS IN ONE UNITNet change in NIFTY from 1 January 1999 to 28 February 2007

Net amount of FIIs Investment is 181778.26crs

For each point change in NIFTY the amount to be contributed by FIIs is

NET FIIs

NET NIFTY

1, 81,778.26 crs

2,858.55crs

=Rs.63.59 crs

Net amount of mutual fund Investment from January 2000 to February 2007 is 19840.83crs

For every point change of NIFTY the amount to be contributed by mutual fund is as

calculated

Mutual fund net

Net of nifty

19,840.83crs

2,858.55crs

= Rs 6.94crs

The total amount of FIIs&MF to be contributed to the market is

= Rs194889.39crs

For every point change in nifty the amount to be contributed by FIIs&MF is

NET of FIIs&MF

NET of NIFTY

1, 94,889.39crs


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2,858.55crs

Rs. 68.17crs

FOR ONE POINT OF CHANGE IN NIFTY THE AMOUNT TO BE CONTRIBUTEDBY FIIS AND MFs ARE AS FOLLOWS

.No Particulars

1 vestment till 28th February .26 cr. 83 cr.

2 Monthly average

3 ntributed for 1 point changein nifty

cr. .

For net investment of FIIS&MF the investment contributed is Rs. 68.17 crs.

INVESTMENT OF FIIS&MF IN 10 POINTS

For 10 point of change the amount to be contributed for FIIs is

= amount invested by FIIs on one point x 10 points = Rs. 63.59 crs x10 = Rs. 635.9 crs.

For 10 point of change the amount to be contributed for Mutual fund is

=amount invested by Mutual Funds on one point x 10 points = Rs. 6.94 crs x10= Rs. 69.4crs

Net investment of FIIs & MF money for every 10 points

= Rs. 68.17 crs x10 = Rs. 681.7crs.

The money to be contributed by FIIs & MF for every 10 points is

FIIs is Rs. 635.9 crs

MF is Rs.69.4 crs

Total Net contribution of both FIIs and MF is Rs. 681.7 crs.

A SERIES OF CHANGES IN FIIs AND MFs ACTIIVITIES IN INDIAN MARKET

The data has taken from January 1999 to February 2007. The FIIs Contributed to the capital

market one of the highest amount is 9465.20 cr in December, 2005.

The lowest contribution in the May 2006 is -8247.20.

In MFs from January 2000 to February 2007 is the highest amount contributed is 7573.04

in May 2006, the lowest amount is -1976.94 in June 2006.


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The Net change in NIFTY during these months is as follows:

March 2006 327.85

May 2006 -486.55

June 2006 57.15

December 2005 184.30

May 2004 -312.50

Net amount of FIIs and MFs is the highest amount is contributed is 11,015.24 in March,

2006 and the lowest amount is -2,246.36 in May 2004

GRAPHICAL DESIGN:

The derived data has been plotted on various charts/graphs, which clearly indicates the

following:1. Net FIIs.

4.1 FIIS NET

FIIs are constantly increasing from the years January 1999 to February 2007.The major investment of FIIs in the above years are in the month of March2004 are

Rs.8769cr. And another major contribution is in the months of December 2005 is Rs.

9465.20cr.

FIIs net

-10000

-5000

0

5000

10000

Jul-06

Nov-05

Mar-05

Jul-04

Nov-03

Mar-03

Jul-02

Nov-01

Mar-01

Jul-00

Nov-99

Mar-99


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FIIs major disinvestment is in the months of May 2004 Rs.-3250.5cr. And another

disinvestment is in the months of May 2006 of Rs. -8247cr.

Net change of Nifty during these months are March 2004 is Rs. -28.40,May 2005 is Rs.-

312.50, December 2005 is Rs. 184.30,May 2006 is Rs. - 486.55.

2. Net Mutual Funds.

4.2 MFS NET

Mutual funds are increasing constantly from January2000 to February2007.

The major contributions of mutual funds to the market is constantly increasing in the months

of December 2004 is Rs. 2724.65cr, September 2005 is

Rs.3233.63cr,March 2006 is Rs. 4482.94cr, May 2006 is Rs.7573.04 cr.

The disinvestment of mutual funds is in months of June 2006 is Rs. -1976.94 cr.

Net change of Nifty is in these months are as September 2005 is Rs. 216.75, December 2004

is Rs.121.70, March 2006 is Rs.327.85, May 2006 is Rs.-486.55.

3. Net of NIFTY.

MFs net

-4000

-2000

0

2000

4000

6000

800010000

Aug-0

6

Jan-0

6

Jun-0

5

Nov-0

4

Apr-04

Sep-0

3

Feb-0

3

Jul-02

Dec-0

1

May-

Oct-00

Mar-00


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4.3 NIFTY NET

As the market is growing constantly in this period.

The major growth of the Nifty is as December 2003 is Rs. 264.50, November 2005 is

Rs.281.30, and March 2006 is Rs. 327.85.

The major decline in Nifty is in the months of May 2004 Rs. -312.50, May 2006 Rs. -

486.55, February 2007 is Rs. -337.40.

4. FIIs & MFs.

nif y n chang

-600.00-500.00

-400.00

-300.00

-200.00

-100.00

0.00

100.00

200.00300.00

400.00

F

-00

F

-01

F

-02

F

-03

F

-04

F

-05

F

-06

F

-07


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4.4 FIIS & MFS

FIIs are constantly increasing from the years January 1999 to February 2007.

The major investment of FIIs in the above years are in the months of March 2004 is

Rs.8769cr. And another major contribution is in the months of December 2005 is

Rs.9465.20cr.

FIIs major disinvestment is in the months of May 2004 Rs.-3250.5cr. And another

disinvestment is in the months of May 2006 of Rs. -8247cr. Net change of Nifty during these months are March2004 is -28.40,May2005 is -312.50,

December2005 is 184.30,May2006 is -486.55

Mutual funds are increasing constantly from January2000 to February2007.

The major contributions of mutual funds to the market is constantly increasing in the months

of December 2004 is Rs. 2724.65cr, September 2005 is Rs. 3233.63cr, March

2006 is Rs. 4482.94cr, May 2006 is Rs. 7573.04cr.

The disinvestment of mutual funds is in months of June 2006 is Rs.-1976.94cr.

Net change of Nifty is in these months are as September 2005 is Rs. 216.75, December 2004

is Rs.121.70, March 2006 is Rs.327.85, May 2006 is Rs. -486.55.

FII &MF

-

-8

-

-

-

8

Nov

-

Jul-

Mar

-

Nov

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