Archive Page 2

25
Jan
08

Derivatives-basics

DERIVATIVES

A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage. Futures contracts, forward contracts, options and swaps are the most common types of derivatives. Because derivatives are just contracts, just about anything can be used as an underlying asset. There are even derivatives based on weather data, such as the amount of rain or the number of sunny days in a particular region.

 Derivatives are generally used to hedge risk, but can also be used for speculative purposes. For example, a European investor purchasing shares of an American company off of an American exchange (using American dollars to do so) would be exposed to exchange-rate risk while holding that stock. To hedge this risk, the investor could purchase currency futures to lock in a specified exchange rate for the future stock sale and currency conversion back into Euros.

TYPES OF DERIVATIVES

FORWARD CONTRACTS
A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. Although the delivery is made in the future, the price is determined on the initial trade date. Most forward contracts don’t have standards and aren’t traded on exchanges. A farmer would use a forward contract to “lock-in” a price for his grain for the upcoming fall harvest.
FUTURES CONTRACT
In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. A futures contract gives the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract. Both parties of a “futures contract” must fulfill the contract on the settlement date. The seller delivers the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to offset their position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations.

 Futures contracts, or simply futures, are exchange traded derivatives. The exchange’s clearinghouse acts as counterparty on all contracts, sets margin requirements, etc.

OPTIONS
An option contract has an exceptional characteristic distinguishing it from any other financial instrument – the holder or owner of an option has the right, but does not have an obligation to buy or sell an underlying instrument at a predetermined price during a specific period or at a specific time. If a person buys a Mercedes, and his best friend wants to buy the car from him, the owner can give his best friend the option to buy the car from him at the date when he wants to sell the car, at a certain price.

There are two basic types of options:

  • An option to buy something, such as the example above. This is known as a call option.
  • An option to sell something. This is called a put option.

 The formal definition of a call option would be that it grants the buyer the right but does not confer an obligation to purchase a certain quantity of the underlying asset at a predetermined price.  The price at which the purchase of the underlying asset will take place if the option is exercised is called the strike price, and this is decided at the initial closing of the option contract.  The amount or-price paid for the option when the option is bought, is called the option premium.

 Likewise, a put option would grant the buyer the right but does not impose an obligation to sell the underlying instrument at a predetermined price.

 A further parameter of an option is the period that the holder has to exercise the option.

  • An American option can be exercised and settled at any time up to the expiry date.
  • A European option can only be exercised using the market prices valid on expiry date and is settled on or within a short time after the expiry date.
SWAPS
Traditionally, the exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changed. Recently, swaps have grown to include currency swaps and interest rate swaps. If firms in separate countries have comparative advantages on interest rates, then a swap could benefit both firms. For example, one firm may have a lower fixed interest rate, while another has access to a lower floating interest rate. These firms could swap to take advantage of the lower rates.
24
Jan
08

Your best Stock Market Investment

It has long been said, and not without justification, ,that stock market investment is not for the faint hearted and when you take into account the fact that many investors over the years have lost everything it is not difficult to see why.

With the economy seemingly in a constant volatile state it might seem that investing in the right stocks and shares would be an impossible task to do accurately. However, since the invention of the computer, modern information technology has make stock market investment much easier to access by people from anywhere in the world. It has also facilitated the task of research which is an important part of any stock market investment especially as your money will be riding on all stocks selected for purchase.

Today, more than ever, stock market investments seem to be enjoying an all time high but it is as well to remember that fortunes can be lost easier than won. So, for those who would like to get the very best out of their stock market investments, the following advice may prove to be helpful.

1. Investing in the stock market carries inherent risk: It is generally believed that there is nothing difficult about buying stocks and, of course, this is quite true. But just buying is not dealing and so the next part of the operation is to sell your stock at a profit and this is where the problems actually start. If you wish to make a profit then you have to wait until the value of the stock begins to rise and, once this happens, to then know at which point to sell for a profit. If you sell too soon you will miss some extra profit but if you wait too long then you may lose out completely should a downturn fall to below your purchase price. In the early days and until you have more experience it is best to be restrained with your outlay – better to lose a little rather than a lot. This is good stock market investment strategy.

2. The ‘trailing stop strategy’: The most experienced investors incorporate this when getting stocks. This involves ‘riding’ their stocks high whilst maintaining an exit strategy should things begin to deteriorate. This is where liquidity plays a vital role in their investment as this liquidity can be easily converted to cash should the need arise.

3. Never invest more than you can comfortably afford: This really just boils down to common sense; it is quite easy to get carried away should a stock market investment look like a really good buy. However it is wise to always remember that there is always the risk of losing ones money so enthusiasm should always be tempered with judgment and restraint. In this way your best stock market investment will not turn out to be a catastrophe.

To sum up, the best advice is to always approach each investment with caution, do the groundwork with regard to research and company background and use an amount of purchasing capital that you are comfortable with and which you can afford to lose. If you heed this advice you will avoid falling into the ‘gambling’ state of mind which can happen all to easily and which has bankrupted many in the past. Read all you can about stocks and shares, take a few instruction courses (which are readily available) and you will find that your best stock market investment can become a reality.

Saving vs Investment

Traditionally, saving has been viewed as quite different from investing. In most savings alternatives, the initial amount of capital or cash remains constant, earning guaranteed rates of interest.

The capital value of investments can go up or down. Returns are not guaranteed. However, creation of money market funds and deregulation of the banking industry have resulted in a variety of savings options that earn variable rates of return.

Savings provide funds for emergencies and for making specific purchases in the relatively near future (generally within two years). The primary goal is to store funds and keep them safe. This is why savings are generally placed in interest-bearing accounts that are safe (such as those insured or guaranteed by the federal government) and liquid (those in the form of cash or easily changed into cash on short notice with minimal or no loss). However, these generally have low yields. Because of the opportunities for earning a higher return with a relatively small pool of funds, some financial experts suggest that savers consider slightly higher risk (but liquid) alternatives for at least part of their savings.

Saved money is insurance. It is insurance against risk, against losing your job, against having a major unexpected repair bill or medical expense in the family. It is the backbone of you and your family’s financial well-being. Saved money grants you financial security. And the more you save, the more financial secure and independent you will be.

The goal of investing is generally to increase net worth and work toward long-term goals. Investing involves risk. Risk of your stocks losing money, or even going bankrupt (Enron, MCI, the airlines, etc. etc.). Risk of interest rates rising, and bond prices falling. Risks of your broker swindled you, or coerced you though his sales pitch to buy speculative investments. Risks of the economy. Risks of a particular industry. Risk of losing your principal. Risk of losing it all, and then some (such as with margin calls).

23
Jan
08

Sovereign Wealth Funds

A Sovereign wealth fund (SWF) is a fund owned by a state composed of financial assets such as stocks, bonds, property or other financial instruments .

Sovereign wealth funds are, broadly defined, entities that can manage the national savings for the purposes of investment. The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and IMF reserve position held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are assets of the sovereign nations which are typically (but not necessarily) held in domestic and different reserve currencies such as the dollar, euro and yen. The names attributed to the management entities may include central banks, official investment companies, state pension funds, sovereign oil funds and so on.

There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. The former can be characterized as maximizing long term return , with the latter serving short term currency stabilization and liquidity management. This distinction points in the right direction, but is still unsatisfactory. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management. Moreover it is widely believed most have diversified hugely into assets other than short term, highly liquid monetary ones (almost no data is available however to back up this assertion). Some central banks even have begun buying equities or derivatives of differing ilk (even if fairly safe ones, like Overnight Interest rate swaps).

Nature and Purpose

SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel it into consumption immediately. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. To reduce the volatility of government revenues, counter the boom-bust cycles’ adverse effect on government spending and the national economy or build up savings for future generations, SWFs may be created. One example of such a fund is The Government Pension Fund of Norway.

Other reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation is partially the expression of a desire to create an international financial center. The Korean Investment Corporation has since been similarly managed.

To download two documents:

  • Why India Should welcome but watch sovereign wealth funds
  • The Rise of Sovereign Wealth Funds

Click here

22
Jan
08

SENSEX: Trading on bourses suspended

MUMBAI (Reuters) – Indian shares fell as much as 12.9 percent on Tuesday before ending down 4.97 percent, a seventh successive loss, as panicked investors sold amid margin calls on declining share portfolios and fears of a global downturn.

Share markets around the world sank for a second day on Tuesday, with Tokyo’s market posting its biggest fall since the session after the Sept. 11, 2001, attacks on the United States, as fears of a U.S.-led global recession intensified.

India’s 30-share BSE index closed 875.4 points down at 16,729.94, its lowest close since Sept. 21. India’s two most valuable firms, Reliance Industries and state-run Oil and Natural Gas Corp led the market lower.
The intra-day fall of 12.9 percent was larger than Monday’s drop of almost 11 percent, but short of a 17 percent intra-day fall in May 2004 that followed an unexpected election result.
Buying interest led by state-run insurance firms helped the market recover some ground. At the close, the index was 21.1 percent below a record high hit on Jan. 10.

The 50-share NSE Nifty index closed down 5.94 percent at 4,899.30 points, having plunged as much as 14.6 percent.

“Over time as better clarity emerges and sanity returns to the market, I think the Indian stock market should bottom out and outperform,” said Chakri Lokapriya, who manages $1.3 billion worth stocks in BRIC markets for BNP Paribas in London.

“I would not say this is the bottom or not, but what I would say at the end of the year the market will close 25 percent higher from its end-December levels.”

IPO SHORT CIRCUIT
A lot of funds have been tied up by Reliance Power’s initial public offer, with the company saying it had received bids worth $190 billion for the $3 billion of shares on offer.

That has drained cash from the market and made it harder for investors to meet margin calls on their falling portfolios.

Margin trading is where investors trade shares without paying the full purchase price. Instead a margin or percentage is paid as collateral that has to be topped up if the share price falls.
Margin calls, both by brokers to investors and by exchanges to brokers, added to the pressure, with brokers saying they were unable to trade until they paid their margin calls.

A rally at the re-open was shortlived, as the market fell to 15,332.42, its lowest since Sept. 3. The market then recovered some losses again, with traders saying state-run Life Insurance Corp and General Insurance Corp were notable buyers.
STOCKS THAT MOVED:
* Reliance Industries Ltd fell 7.3 percent to 2,358.05 rupees, taking its losses over the past six sessions to 26.7 percent.
* ONGC fell 13.6 percent to 962.55 rupees, a seventh straight fall that has seen its shares lose 26.4 percent.
* ICICI Bank, the country’s most valuable bank, fell 4.1 percent to 1,124.75 rupees, a two-month closing low, hit by poor sentiment for financials and banks across the globe.

MAIN TOP 3 BY VOLUME:
* Reliance Natural Resources Ltd on 37.4 million shares.
* Reliance Petroleum on 30.9 million shares.
* Ispat Industries Ltd on 23.3 million shares.
 

Chidambaram urges calm amid stock market falls

NEW DELHI: Investors should stay calm in the face of sharp stock market falls as the fundamentals of the economy are strong, Finance Minister Palaniappan Chidambaram said on Tuesday.

Indian shares fell more than 11 percent in the first few minutes of trade on Tuesday as panic-stricken investors dumped stocks, setting off circuit breakers that automatically halted trade for an hour.

“We had anticipated the market to open on a downward trend and hit the circuit breaker. My advice to investors is to stay calm,” Chidambaram told reporters.

The 10 biggest falls in Sensex history

Here are the 10 biggest falls in the Indian stock market history:

Jan 21, 2008: The Sensex saw its highest ever loss of 1,408 points at the end of the session on Monday. The Sensex recovered to close at 17, 605.40 after it tumbled to the day’s low of 16,963.96, on high volatility as investors panicked following weak global cues amid fears of the US recession.

Jan 22, 2008: The Sensex saw its biggest intra-day fall on Tuesday when it hit a low of 15,332, down 2,273 points. However, it recovered losses and closed at a loss of 875 points at 16,730. The Nifty closed at 4,899 at a loss of 310 points. Trading was suspended for one hour at the Bombay Stock Exchange after the benchmark Sensex crashed to a low of 15, 576.30 within minutes of opening, crossing the circuit limit of 10 per cent.

May 18, 2006: The Sensex registered a fall of 826 points (6.76 per cent) to close at 11,391, following heavy selling by FIIs, retail investors and a weakness in global markets. The Nifty crashed by 496.50 points (8.70%) points to close at 5,208.80 points.

December 17, 2007: A heavy bout of selling in the late noon deals saw the index plunge to a low of 19,177 – down 856 points from the day’s open. The Sensex finally ended with a huge loss of 769 points ( 3.8%) at 19,261. The NSE Nifty ended at 5,777, down 271 points.

October 18, 2007: Profit-taking in noon trades saw the index pare gains and slip into negative zone. The intensity of selling increased towards the closing bell, and the index tumbled all the way to a low of 17,771 – down 1,428 points from the day’s high. The Sensex finally ended with a hefty loss of 717 points ( 3.8%) at 17,998. The Nifty lost 208 points to close at 5,351.

January 18, 2008: Unabated selling in the last one hour of trade saw the index tumble to a low of 18,930 – down 786 points from the day’s high. The Sensex finally ended with a hefty loss of 687 points ( 3.5%) at 19,014. The index thus shed 8.7% (1,813 points) during the week. The NSE Nifty plunged 3.5% (208 points) to 5,705.

November 21, 2007: Mirroring weakness in other Asian markets, the Sensex saw relentless selling. The index tumbled to a low of 18,515 – down 766 points from the previous close. The Sensex finally ended with a loss of 678 points at 18,603. The Nifty lost 220 points to close at 5,561.

August 16, 2007: The Sensex, after languishing over 500 points lower for most of the trading sesion, slipped again towards the close to a low of 14,345. The index finally ended with a hefty loss of 643 points at 14,358.

April 02, 2007: The Sensex opened with a huge negative gap of 260 points at 12,812 following the Reserve Bank of India [Get Quote] decision to hike the cash reserve ratio and repo rate. Unabated selling, mainly in auto and banking stocks, saw the index drift to lower levels as the day progressed. The index tumbled to a low of 12,426 before finally settling with a hefty loss of 617 points ( 4.7%) at 12,455.

August 01, 2007: The Sensex opened with a negative gap of 207 points at 15,344 amid weak trends in the global market and slipped deeper into the red. Unabated selling across-the-board saw the index tumble to a low of 14,911. The Sensex finally ended with a hefty loss of 615 points at 14,936. The NSE Nifty ended at 4,346, down 183 points. This is the third biggest loss in absolute terms for the index.

21
Jan
08

Global markets plunge on US recession fears

LONDON (AP) : European and Asian stock markets plunged Monday following declines on Wall Street last week amid investor pessimism over the U.S. government’s stimulus plan to prevent a recession.
 
The U.K. benchmark FTSE-100 dropped 3.9 percent to 5,673.1; France’s CAC-40 Index plunged 4.5 percent to 4,861.2, while Germany’s slumped 5.35 percent to 6,922.7.
 
In Asia, India’s benchmark stock index tumbled 7.4 percent, while Hong Kong’s blue-chip Hang Seng index plummeted 5.5 percent to 23,818.86, its biggest percentage drop since the Sept. 11, 2001, terror attacks.
 
Investors dumped shares because they were skeptical that an economic stimulus plan President George W. Bush announced Friday would shore up the economy that has been battered by problems in its housing and credit markets. The plan, which requires approval by Congress, calls for about $145 billion worth of tax relief to encourage consumer spending.
 
Concerns about the outlook for the U.S. economy, a major export market for Asian companies, has sent the region’s markets sliding in 2008. Just last Wednesday, the Hang Seng index sank 5.4 percent.
 
“It’s another horrible day,” said Francis Lun, a general manager at Fulbright Securities in Hong Kong. “Today it’s because of disappointment that the U.S. stimulus (package) is too little, too late and investors feel it won’t help the economy recover.”
 
Wall Street: Waiting for the pain to end
 
Japan’s benchmark Nikkei 225 index slid 3.9 percent to close at 13,325.94 points, its lowest close in more than 2 years. China’s Shanghai Composite index plunged 5.1 percent, partly on worries about mainland Chinese banks’ exposure to risky U.S. mortgage investments.
 
Some analysts predict that Asia won’t suffer dramatically from a U.S. recession because increased trade and investment within Asia has made the region less reliant on the United States than in the past. Excluding Japan, 43 percent of Asia’s exports go to other nations in the region, Lehman Brothers calculates, up from 37 percent in 1995.
 
But on Monday, uncertainty and pessimism reigned.
 
In Tokyo trading, exporters got hit hard, partly because of the yen’s recent strength against the dollar. Toyota Motor Corp. lost 3.3 percent and Honda Motor Co. sank 3.4 percent.
 
Shares of Bank of China dropped 6.4 percent in Hong Kong after the South China Morning Post newspaper reported that the bank is expected to announce a “significant writedown” in U.S. subprime mortgage securities, citing unidentified sources. In Shanghai, the bank’s stock declined 4.1 percent.
 
I ndia’s benchmark Sensex index fell 1,353 points, or 7.4 percent – its second-biggest percentage drop ever – to 17,605.35 points. At one point, it was down nearly 11 percent.
 
The decline hit companies across the board, with power utility Reliance Energy Ltd. (RELF.F) falling 16.4 percent. Major software company Tata Consultancy Services Ltd. (TACSF ) slid 7.6 percent
 
“A gloomy U.S. climate has affected the global markets. Even if those markets recover, it will take some time for the recovery to reach India because today’s fall has been so drastic,” said Jayant Pai, of the Mumbai investment company IL&FS Ltd. 
 

World shares tumble as Bush fails to calm US recession fears 

Global stock markets plunged Monday, with Tokyo tumbling to its lowest level in more than two years as US President George W. Bush’s tax plan to revive the world’s largest economy disappointed investors.
After heavy losses in Asian trade, it was the turn of the European markets to suffer, with the main bourses posting losses of between three and five percent by midday as investors headed for the exits, dealers said.
They said that after high hopes that Bush would announce strong measures to prevent the US economy going into recession, the markets did not find enough to offset all the bad news coming through on the banks and the collapse of the US housing market.

The foreign exchange market, however, reacted calmly and some dealers described the shares sell-off as another short-lived, knee-jerk reaction which offered a buying opportunity.
“If (US) interest rates are cut to the extent we and other expect, the likelihood is that today’s share prices will look like silly values in 12 month’s time, if not before,” said Mike Lenhoff, chief strategist at Brewin Dolphin Securities.

 Markets were reacting to Bush’s plan announced last Friday for 140 billion dollars (97 billion euros) in temporary tax cuts and other measures.

RISK AVERSION
Such falls on equity markets sometimes signal to large investors that it is time to buy. But leading investment bank Morgan Stanley said on Monday that was not the case now, at least as far as Europe was concerned.

“We are not compelled to buy yet despite bearish sentiment,” its European equity strategy team said in a note. “We continue to prefer cash over equities.”

Recent polls show institutional investors with large cash holdings, a sign of deep concern about the future direction of assets.

The global equity market rout, meanwhile, promoted currency investors to liquidate risky positions, lifting the low-yielding Japanese yen while the dollar gained on the view no country will escape the economic downturn.

21
Jan
08

Markets crash, Sensex falls 1408 points

Mumbai, January 21: The Indian stock market suffered its biggest single-day fall, losing 1,408.35 points on panic selling triggered by weak global cues.

The fall in the 30-share Sensex surpassed that 826- points loss witnessed on May 18, 2006. Today’s fall was, however, only the fifth biggest in percentage terms.

The index closed at 17,605.35, after moving between 18,919.57 and 16,951.50 points. It had shed a record 2062.20 in intra-day trade that saw it break three 1000-point barriers — 19,000, 18,000 and 17,000 points.

This was the longest six-day falling streak for the sensex, which has suffered a total loss of 3,170.08 points. It set an all-time high peak at 21,206.77 on January 10.
In similar fashion, the National Stock Exchange index Nifty suffered a record loss of 496.50 points, the biggest in the bourse’s history. It closed at 5208.80.

Inside Story:

Following the hefty 1,814-point loss last week, the Sensex opened with a negative gap of 94 points at 19,014, and continued to drift deeper into red as the day progressed.

Relentless selling in the last session saw the index tumble to a low of 16,951 – down 2,063 points ( 10.8%) from the previous close. (Since the index had dropped over 10% after 1400 hrs, the circuit limit was placed at 15%).

Bargain hunting at lower levels saw the index recover some ground, and finally end at 17,605 – down 1,408 points ( 7.4%); the biggest-ever loss in absolute terms and also the first-ever four digit loss for the index.

 

Date Close Previous Close Change Percentage Change
21-Jan-08 17605.40 19013.70 (1,408.35) (7.4) 
18-May-06 11391.43 12217.81 (826.38 ) (6.8 ) 
17-Dec-07 19261.35 20030.83 (769.48 ) (3.8 ) 
18-Oct-07 17998.39 18715.80 (717.43) (3.8 ) 
18-Jan-08 19013.70 19700.80 (687.12) (3.5)

 

While the Midcap Index plunged 1,012 points (11.4%) to 7,882, the Smallcap Index tumbled 1,249 points ( 10.3%) to 9,443.

The NSE Nifty shed 496 points (8.7%) at 5,209.

The BSE breadth was extremely negative – out of 2,810 stocks traded, 2,657 declined, 139 advanced and 14 were unchanged.

INDEX SHAKERS

Reliance Energy and ACC crashed around 16% each to 1,776 and Rs 728, respectively.

Bajaj Auto tumbled over 15% to Rs 2,064. NTPC slumped over 14% to Rs 206, and Reliance Communications plunged nearly 13% to Rs 613.

Hindalco and DLF dropped over 10% each to Rs 166 and Rs 904, respectively.

Grasim and Reliance slipped over 9% each to Rs 3,025 and Rs 2,544, respectively.

Tata Motors, BHEL and ONGC declined around 8% each to Rs 654, Rs 2,114 and Rs 1,114, respectively.

Mahindra & Mahindra, Tata Steel and TCS shed 7.5% each at Rs 673, Rs 722 and Rs 836, respectively.

SBI and Hindustan Unilever dropped around 7% each to Rs 2,200 and Rs 200, respectively.

Larsen & Toubro, Ranbaxy and Cipla were down 6% each at Rs 3,689, Rs 363 and Rs 190, respectively.

ICICI Bank and HDFC declined nearly 6% each to Rs 1,173 and Rs 2,660, respectively.

Bharti Airtel, Infosys, ITC, Maruti, HDFC Bank, Ambuja Cements and Wipro were down 3-5% each.

VALUE & VOLUME TOPPERS

Reliance topped the value chart with a turnover of Rs 663.60 crore followed by Reliance Natural Resources (Rs 491.70 crore), Reliance Energy (Rs 466.40 crore), Reliance Petroleum (Rs 456.80 crore) and Reliance Capital (Rs 340.50 crore).

Reliance Natural Resources led the volume chart with trades of around 2.75 crore shares followed by Ispat Industries (2.55 crore), Reliance Petroleum (2.47 crore), Tata Teleservices (1.53 crore) and IFCI ( 1.49 crore).

19
Jan
08

Mutual Funds Basics

WHAT ARE MUTUAL FUNDS?

Mutual funds are money-managing institutions set up to professionally invest the money pooled in from the public. These schemes are managed by Asset Management Companies (AMC), which are sponsored by different financial institutions or companies.

Each unit of these schemes reflects the share of investor in the respective fund and its appreciation is judged by the Net Asset Value (NAV) of the scheme. The NAV is directly linked to the bullish and bearish trends of the markets as the pooled money is invested either inequity shares or in debentures or treasury bills. Indian Mutual Funds unveils this multi-dimensional avenue, with its intricacies, in a fashionable manner as mutual funds up-hold ample scope of generating decent returns by some thoughtful investment

 Concept of Mutual Funds

 

Mutual Fund Operation Flow Chart

Mutual Fund Operation Flow Chart

 Mutual Funds – Organisation

There are many entities involved and the diagram below illustrates the organisational set up of a mutual fund:

Organisation of a Mutual Fund

Organisation of a Mutual Fund

Advantages of Mutual Funds

 The advantages of investing in a Mutual Fund are:

  • Diversification: The best mutual funds design their portfolios so individual investments will react differently to the same economic conditions. For example, economic conditions like a rise in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other securities in the portfolio will respond to the same economic conditions by increasing in value. When a portfolio is balanced in this way, the value of the overall portfolio should gradually increase over time, even if some securities lose value.
  • Professional Management: Most mutual funds pay topflight professionals to manage their investments. These managers decide what securities the fund will buy and sell.
  • Regulatory oversight: Mutual funds are subject to many government regulations that protect investors from fraud.
  • Liquidity: It’s easy to get your money out of a mutual fund. Write a check, make a call, and you’ve got the cash.
  • Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.
  • Low cost: Mutual fund expenses are often no more than 1.5 percent of your investment. Expenses for Index Funds are less than that, because index funds are not actively managed. Instead, they automatically buy stock in companies that are listed on a specific index
  • Transparency
  • Flexibility
  • Choice of schemes
  • Tax benefits
  • Well regulated

Drawbacks of Mutual Funds

Mutual funds have their drawbacks and may not be for everyone:

  • No Guarantees: No investment is risk free. If the entire stock market declines in value, the value of mutual fund shares will go down as well, no matter how balanced the portfolio. Investors encounter fewer risks when they invest in mutual funds than when they buy and sell stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing money.
  • Fees and commissions: All funds charge administrative fees to cover their day-to-day expenses. Some funds also charge sales commissions or “loads” to compensate brokers, financial consultants, or financial planners. Even if you don’t use a broker or other financial adviser, you will pay a sales commission if you buy shares in a Load Fund.
  • Taxes: During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made.
  • Management risk: When you invest in a mutual fund, you depend on the fund’s manager to make the right decisions regarding the fund’s portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers.



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