Investment Portfolio

Summer Project Completed under

Business Club


Team Members:
Akhil Garg
Yash Parikh


Introduction


Financial Markets especially stock markets, bonds, investment risks,
mutual funds- these are some terms which often hear in
newspapers, televisions but most of us do not have a clear idea of
what they are. This investment world had always fascinated our
team, and hence we decided to do a proper study of financial
markets and common investment instruments available. The project
is an aim to understand three basic investing avenues stocks,
bonds and mutual funds, what they are, how does the money flow
works, how these securities are priced, their different types and
how each of these markets have evolved in India. We also have a
look at how we, as investors, can assess entrerprises before we
invest our hard-earned money in them.









Investment Portfolio
Investment portfolio refers to the set of securities in which some
entity has invested. A portfolio investment is made with the
expectation of earning a return on it. The composition of
investments in a portfolio depends on a number of factors such as
investors risk tolerance, investment horizon and amount invested.
Portfolio investment is distinct from direct investment, which
involves taking a sizeable stake in a target company and possibly
being involved with its day-to-day management.



Stocks

Stock is a share in the ownership of a company. Stock represents a
claim on the company's assets and earnings. Profits are paid out in
the form of dividends.
The claim on assets is relevant if a company goes bankrupt. In case
of liquidation, shareholders receive what's left after all the creditors
have been paid. Stocks have limited liability as the owner of a stock
is not personally liable if the company is not able to pay its debts.
Shareholders vote some members as boards of Directors who make
decisions on major company policies. Usually one vote per share is
alloted. Board of directors may or may not hold shares of the
company.


Why do companies issue stocks?
Every company needs to raise money for its day to day transactions.
The two ways to do so are debt financing and equity financing.
Issuing stock is advantageous for the company as it does not require
the company to pay back the money or make interest payments
along the way. Moreover, in case of liquidation, it is the investors
who lose out their money and hence, risk is transferred to them.
Stock Markets
Equity markets, or stock markets, specialize in the buying and
selling of equity securities of companies. There are two types of
stock markets:
(i) Primary Market : This is where companies originally
issue stock in their companies, a process known as an
Initial Public Offering (IPO). Investment bankers advise a
company on the process and can also act as brokers and
dealers for new stock issues.

(ii) Secondary Market : This is where investors trade
previously-issued securities without the involvement of
the issuing-companies. Usually this is the market we talk
about when we say stock market.

Kinds Of Stocks
Mainly there are two types of stocks:
(i) Common Stocks : Common shares represent
ownership in a company and a claim (dividends) on a
portion of profits. Investors get one vote per share to
elect the board members, who oversee the major
decisions made by management. Dividend are paid to
stock holders if company performs well, but may not be
paid if it underperforms.
(ii) Preferred Stocks : Preferred stock represents some
degree of ownership in a company but doesn't come with
the same voting rights. With preferred shares, investors
are guaranteed a fixed dividend forever unlike common
stocks. In the event of liquidation, preferred shareholders
are paid off before the common shareholder. Preferred
stock may be callable, meaning that the company has the
option to purchase the shares from shareholders at
anytime for any reason.


Stock Exchange
A marketplace in which equity securities are traded. The core
function of a stock exchange is to ensure fair and orderly trading, as
well as efficient dissemination of price information for any
securities trading on that exchange. Exchanges give companies,
governments and other groups a platform to sell securities to the
investing public.
Exchanges are located all around the globe, with some of the more
famous ones being the New York Stock Exchange (NYSE), Nasdaq
and the Tokyo Stock Exchange. In India we have BSE( Bombay Stock
Exchange) and NSE(National Stock Exchange). Each stock exchange
has a particular number of companies listed. Stock exchanges also
have a benchmark index, which indicates whether stock prices have
gone up or down as a whole that day.

Pricing Of Stocks
Stocks are not priced like normal commodities in the market,
subject to cinditions of demand and supply. The value of a stock
depends on its future valuation by the public.
Every time a stock is sold, the exchange records the price at which it
changes hands. If, a few seconds or minutes later, another trade
takes place, the price at which that trade is made becomes the new
market price, and so on. Organized exchanges like the New York
Stock Exchange will occasionally suspend trading in a stock if the
price is excessively volatile, if there is a severe mismatch between
supply and demand. But in normal circumstances, there is no official
arbiter of stock prices, no person or institution that decides a
price. The market price of a stock is the price at which a willing
buyer and seller agree to trade.
If an investor has concluded from his analysis that a company will
earn substantial profits in the future, he would be willing to pay a
higher price for that stock in expectation of higher returns. This
increases the price of the stock. On the other hand, if he realizes that
the future of the company is bleak, he would be willing to sell his
stock at lower prices to prevent incurring loss. This reduces the
price of the stock.
The vast bulk of stock trades are made by professional traders who
buy and sell shares all day long, hoping to profit from small changes
in share prices. Since these traders do not hold stocks over the long
haul, they are not terribly interested in such long-term
considerations as a companys profitability or the value of its assets.
They are interested in such factors mostly insofar as news that
would affect a companys long-term prospects might cause other
traders to buy the stock, causing its price to rise. If a trader believes
that others will buy shares, in the expectation that prices will rise,
then she will buy as well, hoping to sell when the price rises. If
others believe the same thing, then the wave of buying pressure
causes the price to rise.
Stock prices have no relation with the volume of trading for that
stock. Sensex can rise sharply on a day of thin trading, or slide gently
on a day of heavy trading. Rising and falling markets show change in
investors opinion about future of companies, and heavy volume
shows switching of investors opinions.


Stock Market Crash
Stock Market Crash refers to a rapid and often unanticipated drop in
stock prices. A stock market crash can be the result of major
catastrophic events, economic crisis or the collapse of a long-term
speculative bubble. Stock market crashes wipe out equity-
investment values and are most harmful to those who rely on
investment returns for retirement. Although the collapse of equity
prices can occur over a day or a year, crashes are often followed by a
recession or depression.
Recession is a significant decline in activity across the economy,
lasting longer than a few months. An extreme recession which lasts
for more than two years is termed as depression.

Stock Market Of India

Indian Stock Market is one of the oldest Stock Market in Asia. East
India Company used to transact Loan Securities by the end of 18th
Century. In the 1830s, trading on corporate stocks and shares in
Bank and Cotton presses took place in Bombay.

Establishment of BSE (Bombay Stock Exchange)
Few informal groups of Stock Brokers organized themselves in 1875
and were formally organized as Bombay Stock Exchange (BSE). In
1956, the Government of India recognized the Bombay Stock
Exchange as the first Stock Exchange in the country under the
Securities Contracts Act. In 1986, Bombay Stock Exchange
developed BSE Sensex (Sensex = Sensitive Index), an index of top 30
companies, which gave a means to measure the overall performance
of the Exchange.

Establishment of SEBI (Securities and Exchange Board of
India)
Until late 1980s, BSE ran with low transparency and an unreliable
clearing and settlement systems. Towards the end of the 1980s, new
economic forces, the economic growth and currency crisis
emphasized the need for modernization of the financial system.
Government created the Securities and Exchange Board of India
(SEBI) in 1988.

Establishment of NSE (National Stock Exchange)
In April 1992, Bombay Stock Exchange crashed due to Harshad
Mehta Scam. Finance minister Mr. Manmohan Singh urged the need
of other Stock Exchange in competition to BSE. In November 1992,
NSE (National Stock Exchange) was established as the first
electronically traded Stock Exchange in India. After a few years of
operations, the NSE has become the largest stock exchange in India.
Today the NSE takes the 14th position in the top 40 futures
exchanges in the world and has roughly 66% of equity spot turnover
and roughly 100% of equity derivatives turnover.
In 1996, the National Stock Exchange of India launched S&P CNX
Nifty. CNX Nifty (Nifty = National Fifty) is a diversified index of 50
stocks from 25 different economy sectors.

Some Statistics
Since 2007, stock markets have seen highs and lows. Indias GDP has
more than doubled. The money supply in the system total deposits
in banks for instance, has nearly tripled. Yet the growth in volumes
in the stock market has, for the most part, not happened.
India has gone from about 1100 securities traded daily to about
1600, and even with a near 50% increase in numbers, and a jump of
Nifty from 5000 in 2007 to nearly 6000 today, volumes remain just
around 10000 cr. per day.


The Great Indian Stock Market Story of the last twenty years is only
about four years, 2003- 2007. We could add the stellar 1991-92 time
when Harshad Mehta pushed the market up 3x in one year, but
essentially, just five years of the last twenty two have accounted for
nearly all of stock market returns.
A person putting money in stocks in 1991 would have made less
money than by putting money in long term bonds. In fact the
market, in September 2001 was just about 49% higher than
September 1991, a compounded return that would give an investor
less than a savings bank account deposit. From 2007 to now, the
total market return is a miserable 5.9% per year.
Nearly all of the growth in Indias markets were between 2003 and
end 2007. The graph shows that timing and stock picking can have
an advantage over indexed investing, a fact which gave rise to active
management.

Indian Stock Market On Global Scale


Sector Rotation In The Last Decade
Just as a country's influence over global economics evolves, so do
the sectors of an economy. The economies of 1900 and 2000 had
few similarities. Of particular note are the sectors that were small in
1900 and 2000. For instance, 84% of the sectors today (represented
by market capitalization) were of immaterial size or were non-
existent at the beginning of the last century. Technological
advancements have a big impact on the stock market. Just as
railroads consumed the investing public in the latter part of the
nineteenth century, computers and the internet did the same at the
end of the twentieth century.










Bonds

Bonds represent loans by investors to a company. In a bond
contract, the investor purchases a certificate from the issuer in
exchange for a stream of interest payments and the return of a
principal amount at the end of the contract. Interest payments are
made at a predetermined rate and schedule. Bonds are fixed-
income securities because the investor knows the exact amount of
cash he will get back if he holds the security until maturity.
Some terms associated with bonds:

Face Value
The face value is the amount of money a holder will get back once a
bond matures. Corporate bonds normally have a par value of $1,000,
but this amount can be much greater for government bonds.


Coupon
The coupon is the amount the bondholder will receive as interest
payments. The coupon is expressed as a percentage of the face
value. A rate that stays as a fixed percentage of the par value is a
fixed-rate bond. In a floating-rate bond, the interest rate is tied to
market rates through an index, such as the rate on Treasury bills. All
things being equal, a lower coupon means that the price of the bond
will fluctuate more.


Maturity
The maturity date is the date in the future on which the investor's
principal will be repaid. Maturities can range from as little as one
day to as long as 30 years. A bond that matures in one year is much
more predictable and thus less risky than a bond that matures in 20
years. Therefore, in general, the longer the time to maturity, the
higher the interest rate. Also, all things being equal, a longer term
bond will fluctuate more than a shorter term bond.




Issuer
The issuer of a bond is a crucial factor to consider, as the issuer's
stability is investors main assurance of getting paid back. The U.S.
government is far more secure than any corporation. Its default
risk is extremely small - so small that U.S. government securities are
known as risk-free assets. The reason behind this is that a
government will always be able to bring in future revenue through
taxation. A company, on the other hand, must continue to make
profits, which is far from guaranteed. This added risk means
corporate bonds must offer a higher yield in order to entice
investors - this is the risk/return tradeoff in action.

The bond rating system helps investors determine a company's
credit risk. Blue-chip firms, which are safer investments, have a high
rating, while risky companies have a low rating. The chart below
illustrates the different bond rating scales from the major rating
agencies in the U.S.: Moody's, Standard and Poor's and Fitch
Ratings.

Bond Rating
Grade Risk
Moody\'s S&P/ Fitch
Aaa AAA Investment Highest Quality
Aa AA Investment High Quality
A A Investment Strong
Baa BBB Investment Medium Grade
Ba, B BB, B Junk Speculative
Caa/Ca/C CCC/CC/C Junk
Highly
Speculative
C D Junk In Default

If the company falls below a certain credit rating, its grade changes
from investment quality to junk status. Junk bonds are aptly named:
they are the debt of companies in some sort of financial difficulty.
Because they are so risky, they have to offer much higher yields than
any other debt. Hence, not all bonds are inherently safer than stocks.
Certain types of bonds can be just as risky, if not riskier, than stocks.



Why do companies issue bonds?
Like people, companies can borrow from banks, but issuing bonds is
often a more attractive proposition. The interest rate companies pay
bond investors is often less than the interest rate they would be
required to pay to obtain a bank loan. Since the money paid out in
interest detracts from corporate profits, and companies are in
business to generate profits, minimizing the interest amount that
must be paid to borrow money is an important consideration. It is
one of the reasons healthy companies that dont seem to need the
money often issue bonds when interest rates are at extremely low
levels. The ability to borrow large sums of money at low interest
rates gives corporations the ability to invest in growth,
infrastructure and other projects.

Issuing bonds also gives companies significantly greater freedom to
operate as they see fit - free from the restrictions that are often
attached to bank loans. If lenders often require companies to agree
to a variety of limitations, such as not issuing more debt or not
making corporate acquisitions, until their loans are repaid in full,
such restrictions can hamper a companys ability to do business and
limit its operational options. Issuing bonds enables companies to
raise money with no such strings attached.
Moreover, there are downsides to stock issuance that may make
bonds the more attractive proposition. With bonds, companies that
need to raise money can continue to issue new bonds as long as they
can find investors willing to act as lenders. The issuance of new
bonds has no effect on ownership of the company or how the
company is operated. Stock issuance, on the other hand, puts
additional stock shares in circulation, which means that
future earnings must be shared among a larger pool of investors.
This can result in a decrease in earnings per share (EPS), putting
less money in owners' pockets. Issuing more shares also means that
ownership is now spread across a larger number of investors, which
often makes each owners share worth less money. Since investors
buy stock to make money, diluting the value of their investments is
not a favorable outcome. By issuing bonds, companies can avoid this
outcome. Bond issuance enables corporations to attract a large
number of lenders in an efficient manner. Record keeping is simple,
because all bondholders get the exact same deal with the same
interest rate and maturity date. Companies also benefit from
flexibility in the significant variety of bond offerings available to
them. A quick look at some of the variations highlights this
flexibility.

The basic features of a bond - credit quality and duration - are the
principal determinants of a bond's interest rate. In the bond
duration department, companies that need short-term funding can
issue bonds that mature in a short time period. Companies that need
long-term funding can stretch their loans to 10, 30, 100 years or
even more. So-called perpetual bonds have no maturity date, but
rather pay interest forever.

Credit quality stems from a combination of the issuing companys
fiscal health and the length of the loan. Better health and short
duration generally enable companies to pay less in interest. The
reverse is also true, with less fiscally healthy companies and those
issuing longer-term debt generally being forced to pay higher
interest rates to entice investors into lending money.
Types Of bonds

Government Bonds
In general, fixed-income securities are classified according to the
length of time before maturity. These are the three main categories:

Bills - debt securities maturing in less than one year.
Notes - debt securities maturing in one to 10 years.
Bonds - debt securities maturing in more than 10 years.

Marketable securities from the U.S. government - known collectively
as Treasuries - follow this guideline and are issued as Treasury
bonds, Treasury notes and Treasury bills . All det issued by United
States is regarded as extremely safe, as is the debt of any stable
country. The debt of many developing countries, however, does
carry substantial risk. Like companies, countries can default on
payments.


Corporate Bonds
Large corporations have a lot of flexibility as to how much debt they
can issue. Generally, a short-term corporate bond is less than five
years; intermediate is five to 12 years, and long term is over 12
years. Corporate bonds are characterized by higher yields because
there is a higher risk of a company defaulting than a government.
The upside is that they can also be the most rewarding fixed-income
investments because of the risk the investor must take on.
Zero-Coupon Bonds
This is a type of bond that makes no coupon payments but instead is
issued at a considerable discount to par value, so that the investor
receives a one time payment, but higher than the amount he
invested.


Interest Rate
The market offered rate of interest reflects three factors:
Pure rate of interest
Premium that reflects expected inflation
Premium for risk

Pure Interest Rate
The pure interest rate is the rate for a risk-free security when no
inflation is expected. The interest rate on short-term U.S. Treasury
securities is considered to be a close approximation for the real,
risk-freerate in a non-inflationary environment. The pure rate
constantly changes over time, depending on economic conditions.
The two most important influences on the risk-free rate are the
expected rate of return investors can earn on their productive assets
and the time preference of consumers for current-versus-future
consumption. In recent years it has fluctuated between 2% and 4%.

Inflation Premium
Inflation has a great influence on interest rates because it erodes the
purchasing power of money over time. Investors build in an
inflation premium to compensate for this loss of value. For longer
time periods, the inflation premium is the expected average rate
over that period. As with the risk-free rate, the inflation premium is
not constant, it is always changing based on investors' expectations
of the future level of inflation.


Risk Premium
Counterparty (default) risk
Counterparty (default) risk is the chance that the borrower will not
be able to pay the interest or pay off the principal of a loan. It is
generally considered that U.S. Treasury securities have no default
risk. Several specific ratings are used to identify and classify the
creditworthiness of corporations and governments to determine
how large the risk premium should be. A corporation with a AAA
rating will have a smaller default risk than a firm with a BBB rating
and, therefore, will be able to borrow capital at a lower interest rate.



Liquidity risk
Liquidity refers to the marketability of assets the ease with which
assets can be sold for cash on short notice at a fair price. Investors
may require a premium return on an asset to compensate for a lack
of liquidity. The securities which are harder to sell in the secondary
market, offer high liquidity premium to attract investors.


Yield
Yield is a figure that shows the return an investor gets on a bond.
The simplest version of yield is calculated using the following
formula: yield = coupon amount/price. When you buy a bond at par,
yield is equal to the interest rate. When the price changes, so does
the yield. When price goes up, yield goes down and vice versa.
Hence, the bond's price and its yield are inversely related.
A yield-to-maturity calculation is made by determining the interest
rate (discount rate) that will make the sum of a bond's cash flows,
plus accrued interest, equal to the current price of the bond. This
calculation has two important assumptions: First, that the bond will
be held until maturity, and second that the bond's cash flows can be
re-invested at the yield to maturity.




Bond Pricing



Most bonds are priced relative to a benchmark. Different bond
classifications use different pricing benchmarks.

Some of the most common pricing benchmarks are on-the-run U.S.
Treasuries. Many bonds are priced relative to a specific Treasury
bond. For example, the on-the-run 10-year Treasury might be used
as the pricing benchmark for a 10-year corporate bond issue.

When the maturity of a bond cannot be known with exactness
because of call or put features, the bond is frequently priced to a
benchmark curve. This is because the estimated maturity of
the callable or put-able bond most likely does not coincide exactly
with the maturity of a specific Treasury.

Benchmark pricing curves are constructed using the yields of
underlying securities with maturities from three months to 30
years. Several different benchmark interest rates or securities are
used to construct different benchmark pricing curves. Because there
are gaps in the maturities of securities used to construct a curve,
yields must be interpolated between the observable yields.

One of the most commonly used benchmarks curves is the on-the-
run U.S. Treasury curve, which is constructed using the most
recently issued U.S. Treasury bonds, notes, and bills. Because
securities are only issued by the U.S. Treasury with three month, six
month, two year, three year, five year, 10 year and 30 year
maturities, the yields of theoretical bonds with maturities that lay
between those maturities must be interpolated. This Treasury
curve is known as the interpolated yield curve (or I-curve) by bond
market participants.

After an interest rate increase, newly issued bonds yield larger
interest payments than older bonds. The price of old bonds falls to
attractive levels so that investors will continue to buy them. Older
bonds are priced in the market so that the rate of return paid on the
investment is approximately the same as other investment
opportunities with similar risk and maturity. Hence the general rule:

As interest rates increase, bond prices decrease.
As interest rates decrease, bond prices increase.










Debt Market In India
The total size of the Indian debt market is currently estimated to be
in the range of $92 billion to $100 billion. Indias debt market
accounts for approximately 30% of its GDP. The Indian Bond Market
measured by the estimated value of bonds outstandingis next only
to the Japanaese and Korean bond Markets in Asia. The Indian Debt
Market, in terms of volume, is larger than the equity market. In
terms of daily settled deal, the debt and the forx markets currently
command a volume of Rs. 25000 crore against a meager Rs.1200
crore in the equity markets.
In the post reforms era, a fairly well segmented debt market has
emerged comprising:
(i) Private corporate debt market
(ii) Public Sector Undertaking Bond Market
(iii) Government Securities Market
The government securities market accounts for more than 90% of
the turnover in the debt market. It constitutes the principal segment
of the debt market.
The Indian debt market has traditionally been a wholesale market
with participation restricted to few institutional players- mainly
banks. The banks were the major participants in the government
securities market due to statuory requirements. The turnover in the
debt market too was quite low till the early 1990s. The debt market
was fairly underdeveloped due to the administered interest rate
regime and the availability of investment avenues which gave a
higher rate of return to investors. In the early 1990s, the
government needed a large amount of money for investment in
development and infrastructure projects. The government realized
the need of a vibrant, efficient and healthy debt market and
undertook reform measures. The Reserve Bank put in substantial
efforts to develop the government securities market but its two
segments, the private corporate debt market and public sector
undertaking bond market have not yet fully developed in terms of
voolume and liquidity.
It is debt market which can provide returns commensurate to the
risk, a variety of instruments to match the risk and liquidity
preferences of investors, greater safety and lower volatility. Hence
the debt market has a lot of potential for growth in the future. The
debt market is critical to the development of a developing country
like India which requires a large amount of capital for achieving
industrial and infrastructure growth.
The Reserve Bank Of India regulates the government securities
market and money market while the corporate debt market comes
under the purview of the Securities Exchange and Board of India
(SEBI).







Debt vs. Equity

Bonds are debt, whereas stocks are equity. This is the important
distinction between the two securities. By purchasing equity (stock)
an investor becomes an owner in a corporation. Ownership comes
with voting rights and the right to share in any future profits. By
purchasing debt (bonds) an investor becomes a creditor to the
corporation (or government). The primary advantage of being a
creditor is that one has a higher claim on assets than shareholders
do: that is, in the case of bankruptcy, a bondholder will get paid
before a shareholder. However, the bondholder does not share in
the profits if a company does well - he or she is entitled only to
the principal plus interest.

To sum up, there is generally less risk in owning bonds than in
owning stocks, but this comes at the cost of a lower return.



Financial Ratios
Before investing, one should assess the company through its
financial statements. There are a lot of financial ratios which shows
how the company has been performing lately. Some of them are:

(a) ROCE (Return On Capital Employed)
It is calculated as
ROCE = EBIT / Capital Employed
( EBIT Earnings before Income And Tax)

A higher ROCE indicates more efficient use of capital. ROCE
should be higher than the companys capital cost; otherwise
it indicates that the company is not employing its capital
effectively and is not generating shareholder value.



(b) BVPS (Book Value Per Share)
BVPS is calculated as ratio of Value of common equity and
number of stocks outstanding. It represents a per share
assessment of the minimum value of a companys equity. It
is usually used to determine whether a stock is under or
overvalued.

(c) EPS (Earning Per Share)
It is calculated as ratio of net income less preferred
dividends and outstanding shares. It is the most commonly
used indicator variable. EPS indicates the profitability of the
company. A higher EPS invites the investor to buy stocks for
that company.

(d) ROE (Return On Equity)
It is calculated as ratio of net income and average
stockholder equity. ROE indicates how good a company is at
rewarding its shareholders for their investment. Higher the
ROE, the better it is.

(e) Dividend Yield
A stock's dividend yield is expressed as an annual
percentage and is calculated as the company's annual cash
dividend per share divided by the current price of the stock.
The dividend yield is found in the stock quotes of dividend-
paying companies. Investors should note that stock quotes
record the per share dollar amount of a company's latest
quarterly declared dividend.

(f) Debt Equity Ratio
The debt-equity ratio is a leverage ratio that compares a
company's total liabilities to its total shareholders' equity.
This is a measurement of how much suppliers, lenders,
creditors and obligors have committed to the company
versus what the shareholders have committed. A lower
number means that a company is using less leverage and has
a stronger equity position. However this ratio is not a pure
measurement of a company's debt because it includes
operational liabilities in total liabilities.

Importance Of Diversification

Diversification is a technique that reduces risk by allocating
investments among various financial instruments, industries and
other categories. It aims to maximize return by investing in different
areas that would each react differently to the same event. Most
investment professionals agree that, although it does not guarantee
against loss,diversification is the most important component of
reaching long-range financial goals while minimizing risk.
Diversification can help an investor manage risk and reduce the
volatility of an asset's price movements. However no matter how
diversified your portfolio is, risk can never be eliminated
completely.
Diversification is measured by calculating correlation between
investing instruments. A correlation of 0 means that price
movements of assets are totally unrelated. In practice, it is quite
difficult to have exact 0 correlation but a combination of different
varieties of stocks can help in maintaining a well diversified
portfolio.




Mutual Funds

Mutual Fund is basically a collection of investment instruments.
Mutual Fund 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.

Making money From Mutual funds

Income is earned from dividends on stocks and interest on
bonds, which the fund pays out to fund owners in the form of a
distribution.
When the fund sells securities that have increased in price, the
fund has a capital gain. These gains are also passed on to
investors in a distribution.
If fund holdings increase in price but are not sold by the fund
manager, the fund's shares increase in price. One can then sell
your mutual fund shares for a profit.


Advantages of Mutual Funds

Professional Management - The primary advantage of
funds is the professional management of investors 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 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, risk is spread out. 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 - Just like an individual stock, a mutual fund allows
you to request that your shares be converted into cash at any
time.
Disadvantages of Mutual Funds

Professional Management - Many investors debate
whether or not the professionals are any better than any
common investor at picking stocks. Management is by no
means infallible, and, even if the fund loses money, the
manager still gets paid.

Costs - Creating, distributing, and running a mutual fund is an
expensive proposition. Everything from the manager's salary
to the investors' statements cost money. Those expenses are
passed on to the investors. Since fees vary widely from fund to
fund, failing to pay attention to the fees can have negative long-
term consequences.

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.

Taxes - When a fund manager sells a security, a capital-gains
tax is triggered. Investors who are concerned about the impact
of taxes need to keep those concerns in mind when investing in
mutual funds.
Types Of Funds
All mutual funds are variations of equity, fixed income and money
market funds. Apart from pure bond and equity funds, there are:
Money Market Funds : Most investments are in Treasury
bills, hence risk is low.
Balanced Funds : The strategy is to invest in a combination
of fixed income and equity securities.
International Funds : An international fund invests only
outside ones home country. It is a good choice to introduce
diversification in a portfolio.



Mutual Fund Market In India
The mutual fund industry in India started in 1963 with the
formation of Unit Trust of India, at the initiative of the Government
of India and Reserve Bank of India. The history of mutual funds in
India can be broadly divided into four distinct phases

First Phase - 1964-1987
Unit Trust of India (UTI) was established in 1963 by an Act of
Parliament. It was set up by the Reserve Bank of India and
functioned under the Regulatory and administrative control of the
Reserve Bank of India. In 1978 UTI was de-linked from the RBI and
the Industrial Development Bank of India (IDBI) took over the
regulatory and administrative control in place of RBI. The first
scheme launched by UTI was Unit Scheme 1964. At the end of 1988
UTI had Rs. 6,700 crores of assets under management.

Second Phase - 1987-1993 (Entry of Public Sector
Funds)
1987 marked the entry of non-UTI, public sector mutual funds set
up by public sector banks and Life Insurance Corporation of India
(LIC) and General Insurance Corporation of India (GIC). SBI Mutual
Fund was the first non-UTI Mutual Fund established in June 1987
followed by Canbank Mutual Fund (Dec 87), Punjab National Bank
Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of
India (Jun 90), Bank of Baroda Mutual Fund (Oct 92). LIC
established its mutual fund in June 1989 while GIC had set up its
mutual fund in December 1990. At the end of 1993, the mutual fund
industry had assets under management of Rs. 47,004 crores.

Third Phase - 1993-2003 (Entry of Private Sector Funds)
With the entry of private sector funds in 1993, a new era started in
the Indian mutual fund industry, giving the Indian investors a wider
choice of fund families. Also, 1993 was the year in which the first
Mutual Fund Regulations came into being, under which all mutual
funds, except UTI were to be registered and governed. The erstwhile
Kothari Pioneer (now merged with Franklin Templeton) was the
first private sector mutual fund registered in July 1993.
The 1993 SEBI (Mutual Fund) Regulations were substituted by a
more comprehensive and revised Mutual Fund Regulations in 1996.
The industry now functions under the SEBI (Mutual Fund)
Regulations 1996. The number of mutual fund houses went on
increasing, with many foreign mutual funds setting up funds in India
and also the industry has witnessed several mergers and
acquisitions. As at the end of January 2003, there were 33 mutual
funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India
with Rs. 44,541 crores of assets under management was way ahead
of other mutual funds.

Fourth Phase - since February 2003
In February 2003, following the repeal of the Unit Trust of India Act
1963 UTI was bifurcated into two separate entities. One is the
Specified Undertaking of the Unit Trust of India with assets under
management of Rs. 29,835 crores as at the end of January 2003,
representing broadly, the assets of US 64 scheme, assured return
and certain other schemes. The Specified Undertaking of Unit Trust
of India, functioning under an administrator and under the rules
framed by Government of India and does not come under the
purview of the Mutual Fund Regulations. The second is the UTI
Mutual Fund, sponsored by SBI, PNB, BOB and LIC. It is registered
with SEBI and functions under the Mutual Fund Regulations. With
the bifurcation of the erstwhile UTI which had in March 2000 more
than Rs. 76,000 crores of assets under management and with the
setting up of a UTI Mutual Fund, conforming to the SEBI Mutual
Fund Regulations, and with recent mergers taking place among
different private sector funds, the mutual fund industry has entered
its current phase of consolidation and growth. The graph indicates
the growth of assets over the years.














Active And Passive Portfolio Management

Passive Portfolio Management is based on efficient market
hypothesis which states that at all times markets incorporate and
reflect all information, rendering individual stock picking futile. As a
result, the best investing strategy is to invest in index funds, which,
historically, have outperformed the majority of actively managed
funds. It is a lower risk investment option.
Such management uses models such as CAPM( Capital Asset Pricing
Model) to aid in investing.


Active Management believes that markets are not 100% efficient
and hence it is possible to outperform the market. They believe that
it is possible to profit from the stock market through any number of
strategies that aim to identify mispriced securities. It is a higher risk
option and most academicians regard it impossible to make money
this way.
Active Management is a recent development and for a large majority
of investors, it has been difficult.