Hedging Techniques IN Mutual Funds (Franklin Templeton)

HEDGING TECHNIQUES
IN
MUTUAL FUNDS
(Franklin Templeton)
Submitted to Lovely Professional University
In partial fulfillment of the

Requirements for the award of Degree of
Master of Business Administration
Submitted by Guided by
Arun Sharma Mrs. Shelly
Registration No. 2020070160 Lecturer (Mgt)
LSB
DEPARTMENT OF MANAGEMENT
LOVELY PROFESSIONAL UNIVERSITY
PHAGWARA
(2007-09)
HEDGING TECHNIQUES IN MUTUAL FUNDS 2
OBJECTIVES OF THE STUDY
The purpose of this study is to examine the effectiveness of hedging mutual fund returns
using Index Futures Contracts. Additionally, the study allows understanding the various
issues, such as
1. To study, how hedging techniques reduces the risk in investment.
2. To study the application of derivatives in Mutual funds.
3. To comparison of before and after returns of hedging funds.
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RESEARCH METHODOLOGY
Since the objective is to analyze the effectives of hedging in mutual funds, the data
required is the fact sheet of the mutual fund for the relevant period. Further, from the use
website, the relevant details of derivatives contract were captured.
DATA COLLECTION
There was one method for the data collection:
• Secondary Data
The mechanism involved in secondary data collection, mainly browsing through adequate
journal (related to mutual funds and derivatives), collection of fact sheet of the mutual
fund from the AMC, web portals, & books etc.
Quantitative analysis required ascertaining the returns of the mutual funds for the certain
period and then for same period calculated the hedged returns. Thus, compared both the
returns to arrive at better results.
METHODOLOGY
Mutual Funds: This study uses the daily returns of mutual funds such as Franklin
Bluechip Fund, Franklin Infotech Fund and Franklin Prima fund. The entire funds taken
are growth funds. Daily NAV data was obtained from Association of Mutual Funds in
India and computed daily returns from this data.
After this, I used Chi-Square test to check that Is the Mutual Funds returns are equal to
hedging returns or not ? By this I come to know how hedging returns are reduced the risk
and also comparison of before and after hedging returns.
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Index Futures Contracts: Financial futures provide institutional investors with the
opportunity to hedge their financial risk. These futures are low cost flexible instruments
that can be used as a risk management tool. Similarly, index futures can be used as a
hedge for wide range of
stock, which forms its underlying stock base. The idea of an index future is to provide a
mechanism for fixing returns on the market portfolio. The key to hedging with stock
index futures is that the futures position combined with the exiting cash market position
yields a desired exposure to risk on the overall investment in the underlying asset. This in
effect helps the portfolio manager to alter the market risk on his portfolio without
changing the portfolio composition.
I have used S&P CNX Nifty and CNX IT as hedging instruments for this study. These
contracts were selected based on the concept that the most suitable hedgers for Franklin
Templeton would be the index futures that were written on same or similar underlying
assets. All futures contract selected for this study are liquid in nature. Futures contract
prices are obtained from NSE website. Future contracts mature last Thursday of every
month and there will be three types available based on the maturity, but I have taken the
near month expiry, as the study is based on short term horizon.
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1. INTRODUCTION TO MUTUAL FUNDS
1.1 History
The concept of mutual funds was introduced in India with the formation of Unit Trust of
India in 1963. The first scheme launched by UTI was the now infamous Unit Scheme 64
in 1964. UTI continued to be the sole mutual fund until 1987, when some public sector
banks and Life Insurance Corporation of India and General Insurance Corporation of
India set up mutual funds. It was only in 1993 that private players were allowed to open
shops in the country. Today, 32 mutual funds collectively manage Rs 6713575.19 cr.
under hundreds of schemes.
The industry faced its toughest challenge when the US 64 fiasco shattered the confidence
of investors. However, in 2003, the government bifurcated the erstwhile UTI. One entity
manages the assets of US 64 and some assured return schemes. The other is a regular
mutual fund working under the Sebi regulations. Thanks to the boom in the stock market,
UTI managed to clean up its act and continue to enjoy the confidence of several
investors. The whole industry also came out of the controversy without any major
setbacks.
In the past decade, Indian mutual fund industry had seen a dramatic improvements, both
quality wise as well as quantity wise. Before, the monopoly of the market had seen an
ending phase, the Assets Under Management (AUM) was Rs. 67bn. The private sector
entry to the fund family rose the AUM to Rs. 470 bn in March 1993 and till April 2004, it
reached the height of 1,540 bn.
Putting the AUM of the Indian Mutual Funds Industry into comparison, the total of it is
less than the deposits of SBI alone, constitute less than 11% of the total deposits held by
the Indian banking industry.
The main reason of its poor growth is that the mutual fund industry in India is new in the
country. Large sections of Indian investors are yet to be intellectuated with the concept.
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Hence, it is the prime responsibility of all mutual fund companies, to market the product
correctly abreast of selling.
1.2 Meaning of Mutual Fund

Definition: A mutual fund is simply a financial intermediary that allows a group of
investors to pool their money together with a predetermined investment objective. The
mutual fund will have a fund manager who is responsible for investing the pooled money
into specific securities (usually stocks or bonds). When you invest in a mutual fund, you
are buying shares (or portions) of the mutual fund and become a shareholder of the fund.
Mutual funds are one of the best investments ever created because they are very cost
efficient and very easy to invest in (you don't have to figure out which stocks or bonds to
buy).
The flow chart below describes broadly the working of a mutual fund.
Figure 1
Further, Mutual Fund’s business acts according to the wishes of the investors who created
the pool. In many markets these wishes are translated in to “investment
mandates”. Generally, the investors appoint professional investment managers,
to mange their funds. The same objective is achieved when professional
investment managers create a product , and offer it for investment to the
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investor. This product represents a share in the pool, and pre-states investment
objectives. For example, a mutual fund, which sells a money market mutual
fund is actually obtained investors willingness to invest in a pool that would
invest predominantly in money market instruments.
1.3 Organisation Structure of a Mutual Fund
There are many entities involved and the diagram below illustrates the organizational set
up of a mutual fund
Figure 2
The sponsor is the promoter of a mutual fund. The sponsor establishes the mutual fund
and registers the same with SEBI. Further, Sponsor appoints the trustees,
custodians and the AMC with prior approval of SEBI, and accordance with
SEBI regulations. All the entities are entitled to comply with certain regulatory
requirements. Let us discuss the regulatory requirements of trustees and AMC.
Regulatory requirements for trustees: The mutual fund, which is a trust, is managed either
by a trust company or a board of trustees. Board of trustees and trust
companies are governed by the provisions of the Indian Trust Act. If the
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trustee is a company, it is also subject to the provisions of the Indian

Companies Act. It is the responsibilities of the trustees to protect the interest of
investors, whose fund is managed by the AMC.
Regulatory requirements for the AMC: It is applicable only to the SEBI registered AMCs
can be appointed as investment managers of mutual funds. AMCs are required
to have the minimum net worth of Rs. 10 crores at all times. AMCs are not
allowed to be the trustee of another mutual fund. The investment management
agreement entered into between the trustees and the AMC, spells out the rights
and obligations of both the parties.
1.4 Types of MF
M UT UA L
S CH E M ES A CC O R D ING
TO M A TU RITY
P E R IO D
Figure 3
MF schemes can be classified under two broad heads, namely schemes according to
maturity period and schemes according to investment objective.
O PE N-E N D FUN D/ C LOS E D

-E N D FU ND / G
SCHEME S C HE M E O
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Schemes according to maturity period:
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme
depending on its maturity period.
Open-ended fund or scheme:

An open-ended fund or scheme is one that is available for subscription and repurchase on
a continuous basis. These schemes do not have a fixed maturity period. Investors can
conveniently buy and sell units at Net Asset Value (NAV) related prices which are
declared on a daily basis. The key feature of open-end schemes is liquidity.
CRISIL's composite performance ranking (CPR) measures the performance for each of
the open-ended scheme of Mutual Fund. There are four parameters considered to measure
the performance of a mutual fund such as Risk-adjusted returns of the scheme's NAV,
Diversification of Portfolio, Liquidity and Asset Size.
Closed-end fund/scheme:
A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is
open for subscription only during a specified period at the time of launch of the scheme.
Investors can invest in the scheme at the time of the initial public issue and thereafter
they can buy or sell the units of the scheme on the stock exchanges where the units are
listed. In order to provide an exit route to the investors, some close-ended funds give an
option of selling back the units to the mutual fund through periodic repurchase at NAV
related prices. SEBI Regulations stipulate that at least one of the two exit routes is
provided to the investor i.e. either repurchase facility or through listing on stock
exchanges. These mutual funds schemes disclose NAV generally on weekly basis.
Schemes according to investment objective:
A scheme can also be classified as growth scheme, income scheme, or balanced scheme
considering its investment objective. Such schemes may be open-ended or close-ended
schemes as described earlier. Such schemes may be classified mainly as follows
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Growth / Equity Oriented Scheme:

The aim of growth funds is to provide capital appreciation over the medium to long-
term. Such schemes normally invest a major part of their corpus in equities. Such funds
have comparatively high risks. These schemes provide different options to the investors
like dividend option, capital appreciation, etc. and the investors may choose an option
depending on their preferences. The investors must indicate the option in the application
form. The mutual funds also allow the investors to change the options at a later date.
Growth schemes are good for investors having a long-term outlook seeking appreciation
over a period of time.
Income / Debt Oriented Scheme:

The aim of income funds is to provide regular and steady income to investors. Such
schemes generally invest in fixed income securities such as bonds, corporate debentures,
Government securities and money market instruments. Such funds are less risky
compared to equity schemes. These funds are not affected because of fluctuations in
equity markets. However, opportunities of capital appreciation are also limited in such
funds. The NAVs of such funds are affected because of change in interest rates in the
country. If the interest rates fall, NAVs of such funds are likely to increase in the short
run and vice versa. However, long term investors may not bother about these fluctuations.
Balanced Fund:
The aim of balanced funds is to provide both growth and regular income as such schemes
invest both in equities and fixed income securities in the proportion indicated in their
offer documents. These are appropriate for investors looking for moderate growth. They
generally invest 40-60% in equity and debt instruments. These funds are also affected
because of fluctuations in share prices in the stock markets. However, NAVs of such
funds are likely to be less volatile compared to pure equity funds.
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Money Market or Liquid Fund:

These funds are also income funds and their aim is to provide easy liquidity, preservation
of capital and moderate income. These schemes invest exclusively in safer short-term
instruments such as treasury bills, certificates of deposit, commercial paper and inter-
bank call money, government securities, etc. Returns on these schemes fluctuate much
less compared to other funds. These funds are appropriate for corporate and individual
investors as a means to park their surplus funds for short periods.
Gilt Fund:
These funds invest exclusively in government securities. Government securities have no
default risk. NAVs of these schemes also fluctuate due to change in interest rates and
other economic factors as is the case with income or debt oriented schemes.
Index Funds:
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index,
S&P NSE 50 index (Nifty), etc. These schemes invest in the securities in the same weight
age comprising of an 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 some
factors known as "tracking error" in technical terms. Necessary disclosures in this regard
are made in the offer document of the mutual fund scheme.
Some helpful rules to invest in mutual funds :-
Mutual Funds are increasingly being touted as the retail investors' investment vehicle.
But the key challenge is to choose the right fund. But it's simple. It only requires a bit of
discipline and little time - hardly a cost for a secure financial future. Following are some
rules to help invest better and attain your financial goals.
Know Yourself: The first step towards achieving your goals is that you must know
yourself. Try to get an idea of how much risk you can handle. Do a tolerance test for
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yourself. If your Rs 10,000 investment turning into Rs 6,000 up sets you--even though it
could subsequently bounce back--an aggressive equity fund is not for you.
Reality Check: What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in
two years, a medium term bond fund may not be the right answer. Work on setting
realistic expectations for both your goals and your funds.
Know What You Are Buying: Once you discovered yourself, spend some time for a
close understanding of the funds. The stated objective of a fund as given in a prospectus
is often incomplete and does not reveal much. Based on the readily available portfolio
and fund manager's commentary, you can broadly understand the style and strategy
followed by a fund. This will help you meaningfully diversify your portfolio. This will
also help you assess potential risks. In general, large-cap value funds are less risky than
small-cap growth funds.
Examine Sector Weightings: You must know that funds with large stakes in just one or
two sectors will likely be more volatile than the more evenly diversified funds. Looking
at a fund's sectoral history will help you gain a good perspective. Does the manager move
in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the
manager is ever caught on the wrong foot.
Check out the Fund's Concentration: A portfolio with just 20 or 30 stocks or one that
puts most of its assets in just a few stocks will likely be more volatile than a fund that's
spread among hundreds of stocks. But there could be rewards of concentration. A
concentrated portfolio will also get more bangs for its buck if its stocks work out. You
may want to add a concentrated fund, one that owns fewer stocks or puts most of its
assets in the top 10 or 20 stocks, to your portfolio.
But largely, your core funds should probably be well a diversified and more predictable.
Though a small allocation to a sector-oriented fund, a more-flexible fund, or a more-
concentrated fund could boost your returns.
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Assess Performance Appropriately: Past performance is no indicator of future results.

Investors should commit this statutory quote from mutual fund prospectus,
advertisements and any other literature to memory. It should be recalled more readily
than your bank account number. It should be repeated anytime you consider sending
money to any fund with a 100 per cent three-month gain.
Why? Chances are that a few months of boom will be followed by bust, as it has
happened in 2000. All the ICE concentrated funds, which were topping the charts fell flat
on their face. There was just no escape when their NAVs started declining like nine pins.
What should an investor do? Do not concentrate your mutual fund portfolio or invest in a
concentrated fund. And, above all, don't focus on short-term returns. When choosing a
fund, look for above-average performance, quarter after quarter, year after year.
Know Your Portfolio: Look for areas that are over-represented and for those that are
lacking. For example, will your portfolio be overly concentrated in the large-cap equities
or too much in highly rewarding but wildly volatile infotech stocks? Will you be missing
investments in small-cap stocks?
Be A Disciplined Investor: After you've chosen some funds, stick with them. Don't be
afraid to go ahead.
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2. INTRODUCTION TO DERIVATIVES MARKET
2.1 Definition
Financial markets are, by nature, extremely volatile and hence the risk factor is an
important concern for financial agents. To reduce this risk, the concept of derivatives
comes into the picture. Derivatives are products whose values are derived from one or
more basic variables called bases. These bases can be underlying assets (for example
forex, equity, etc), bases or reference rates. For example, wheat farmers may wish to sell
their harvest at a future date to eliminate the risk of a change in prices by that date. The
transaction in this case would be the derivative, while the spot price of wheat would be
the underlying asset.
2.2 History
The history of derivatives can be traced to the Middle Ages when farmers and traders in
grains and other agricultural products used certain specific types of futures and forwards
to hedge, their risks. Essentially the farmer wants to ensure that he receives a reasonable
price for the grain that he would harvest [say] three to four months later. An oversupply
will hurt him badly. For the grain merchant, the opposite is true. A fall in the agricultural
production will push up the prices. It made sense therefore for both of them to fix a price
for the future. This was how the Futures market first developed in agricultural
commodities such as cotton, coffee, petroleum, soya bean, sugar and then to financial
products such at interest rates, foreign exchange and shares. In 1995 the Chicago Board
of Trade commenced trading in Derivatives.
Derivatives Market in India
In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A) defines
“derivative” to include –
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1. A security derived from a debt instrument, share, loan whether secured or unsecured,
risk instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying
securities. Derivatives are securities under the SC(R)A and hence the trading of
derivatives is governed by the regulatory framework under the SC(R)A.
Equity derivatives trading started in India in June 2000, after a regulatory process which
stretched over more than four years. In July 2001, the equity spot market moved to
rolling settlement. Thus, in 2000 and 2001, the Indian equity market reached the logical
conclusion of the reforms program which began in 1994. It is hence important to learn
about the behavior of the equity market in this new regime.
India’s experience with the launch of equity derivatives market has been extremely
positive, by world standards. NSE is now one of the prominent exchanges, amongst all
emerging markets, in terms of equity derivatives turnover. There is an increasing sense
that the equity derivatives market is playing a major role in shaping price discovery.
Figure 4
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Risks
The risks associated with derivatives are very different to those incurred in the cash
markets. When buying a share for example - a long position - your maximum possible
loss is the amount you originally paid for it.
Derivatives, on the other hand, exhibit a lot of different risk profiles. Some provide
limited risk and unlimited upside potential. For example, the risk of loss with a derivative
contract, which confers a right to buy a particular asset at a particular price, is limited to
the amount you have paid to hold that right. However, profit potential is unlimited.
Others display risk characteristics in which while your potential gain is limited, your
losses are potentially unlimited. For example, if you sell a derivative contract which
confers the right to buy a particular asset at a particular price, your profit is limited to the
amount you receive for conferring that right, but, because you have to deliver that asset to
the counterparty at expiry of the contract, your potential loss is unlimited. Because of the
wide range of risk profiles which derivative contracts exhibit, it is vital that you have a
clear understanding of the risk/return characteristics of any derivative strategy before you
execute it.
Leverage
Apart from the structure of the instrument itself, the source of a lot of the risk associated
with derivative contracts stems from the fact that they are leveraged contracts.
Derivative products are said to be ‘leveraged’ because only a proportion of their total
market exposure needs to be paid to open and maintain a position. This percentage of the
total is called a ‘margin’ in futures markets; and a ‘premium’ in options markets. In this
context, ‘leverage’ is the word used in all English-speaking derivative markets.
Because of leverage your market exposure with derivative contracts can be several times
the cash you have placed on deposit as "margin" for the trade, or paid in the form of a
premium.
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Leverage, of course, can work both in your favour and against you. A derivative which
gives you a market exposure of 10 times the funds placed on deposit is excellent if prices
are moving in your favour, but not so good if they are moving against you, as losses will
mount up very rapidly.
Figure 5
In other words, with leveraged positions, losses are magnified as well as gains.
2.3 FUTURES
A futures contract is a contract to purchase a specific underlying instrument at a specific

time in the future, for a specific price. All futures are exchange-traded contracts and
they're standardized in terms of delivery date, amount and contract terms.
Traders use futures contracts to speculate on the direction of an underlying instrument

(including indices). Banks and other financial institutions use them to hedge their
portfolios against adverse fluctuations in the price of an underlying exposure. Such
hedging is possible because you can short futures contracts - i.e. sell the futures contract.
A futures contract is an agreement between a buyer or seller of the contract and a futures
exchange in which the buyer or seller agrees to take or make delivery of a specific
amount of a particular instrument or commodity, at a specific price, at a specified time.
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All futures are exchange traded contracts and they are standardized in terms of the
delivery date, the amount of the 'underlying' they relate to, and the contract terms. Futures
contracts can also be freely bought and sold before the contract expires.
When an investor buys a futures contract, the investor is said to be long the futures.
Buying (going long) a future commits you to buying the underlying at a future date.
Figure 6
If an investor sells a futures contract, they are said to be short the futures. Selling
(shorting) a future commits you to selling the underlying at a future date.
Figure 7
As we have already seen earlier, futures contracts are contracts to buy or sell a specific
underlying instrument at a specific time in the future, for a specific price.
Selling (shorting) a future commits you to selling the underlying at a future date.
All futures are exchange-traded contracts and they are standardised in terms of the
delivery date, the amount of the 'underlying' they relate to, and the contract terms. They
are also contracts with a limited lifespan - i.e. they expire after a certain date.
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Although futures contracts, if held till "delivery", lead to fulfillment of their

commitments, generally speaking, very few contracts are taken to delivery. Instead,
holders of futures positions will normally "close out" by selling the contract - thus
avoiding the prospect of having to make/take delivery of the underlying.
Margin and leverage
When clients wish to buy or sell a futures contract they instruct a broker, who will be a
member of the exchange where the futures contract is traded. The broker will then
instruct a market maker to execute the order on their behalf.
Unlike trading underlying markets, when you buy a futures contract, it doesn’t involve
actually paying for the full market exposure of the contract you have bought. Rather, the
position is established at that price level. Profits or losses due to any subsequent price
changes are paid out or received on a day to day basis.
A small percentage of the overall contract exposure is deposited as "margin" when a
position is opened - so-called initial margin - and refunded on closing. The size of this
margin bears a relationship to the likely price movements as well as the size of the
position taken.
As long as the position is open this margin is marked-to-market on a daily basis.

Marking-to-market simply means that the size of the margin is adjusted to take account of
the end-of-day value of the open position. If the position has generated a profit this is
credited to the contract holder's account and, indeed, they may be able to withdraw
margin.
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Figure 8
If the position has generated a loss then the customer must deposit additional funds to
restore the margin to its initial level. This payment is called variation margin.
Figure 9
Apart from the small transaction cost per contract bought or sold, the initial and variation
margin are all that an investor has to put up to control a much larger amount. For this
reason, futures contracts, like other derivatives contracts, provide leverage.
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2.3.1 PARTICIPANTS IN THE FUTURES MARKET
There are three kinds of participants in the Futures market. Lets discuss each one of them
in detail
Hedgers
Speculators and
Arbitrageurs
All three must co-exist. A Hedger is risk averse. Typically in India he may be a Treasurer
in a public sector company who wants to know with certainty his interest costs for the
year 2002. Therefore based on current information he would enter into a futures contract
and lock up his interest rate four years hence. But in doing so he consciously ignores
what is called the upside potential - here the possibility that the interest rate may be lower
in the year 2002 than what he had contracted four years earlier. A Hedger therefore plays
it safe. For a hedging transaction to be completed there must be another person willing to
take advantage of the price movements. That is the Speculator.
Contrary to the Hedger who avoids uncertainties the Speculator thrives on them. The
speculator may lose plenty of money if his forecast goes wrong but stands to gain
enormously if he is proved correct. The risk taking associated with speculation is an
integral part of a Derivative market. The third category of participant is the Arbitrageur,
who looks at risk less profit by simultaneously buying and selling the same or similar
financial products in different markets. Markets are seldom perfect and there is a
possibility to take advantage of time or space differentials that exist. Arbitrage evens out
the price variations.
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HEDGING
Suppose you have a position in a cash market, which you want to maintain for whatever
reason – it may be difficult to sell, or perhaps it forms part of your long-term portfolio.
However, you anticipate an adverse movement in its price. With a derivatives hedge it is
possible to protect these assets from the fall in value you fear. Let’s see how.
As we have already said, the value of a derivative contract is related to the value of the
underlying asset it relates to. Because of this, with derivatives, it is possible to establish a
position (with the same exposure in terms of the value of the contract), which will
fluctuate in value almost in parallel with an equivalent underlying position.
It is also possible with derivative contracts to go long or short; in other words you can
take an opposite position to the position you have in a particular underlying asset (or
portfolio).
Hedging involves taking a temporary position in a derivatives contract(s), which is equal

and opposite to your cash market position in order to protect the cash position against
loss due to price fluctuations. As the price moves, loss is made on the underlying, whilst
profit is made on the derivative position, the two canceling each other out.
Protecting assets, which you hold from a fall in value by selling an equivalent number of
derivative contracts, is known as a short hedge.
A futures contract is an agreement between a buyer or seller of the contract and a futures
exchange in which the buyer or seller agrees to take or make delivery of a specific
amount of a particular instrument or commodity, at a specific price, at a specified time.
All futures are exchange traded contracts and they are standardized in terms of the
delivery date, the amount of the 'underlying' they relate to, and the contract terms. Futures
contracts can also be freely bought and sold before the contract expires.
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When an investor buys a futures contract, the investor is said to be long the futures.
A long hedge, on the other hand, involves buying derivatives as a temporary substitute
for buying the underlying at some future point. This is to lock in a buying price. In other
words, you are protecting yourself against an increase in the underlying price between
now and when you buy in the future.
Cash and derivatives markets move together more or less in parallel, but not always at the
same time, or to the same extent. This introduces a certain amount of what is called hedge
inefficiency, which may need to be adjusted. At other times, an imperfect hedge might be
knowingly established, which leaves a small exposure to the underlying market
depending on the risk appetite of the individual.
Hedging: Long security, short Nifty futures
Investors studying the market often come across a security which they believe is
intrinsically undervalued. It may be the case that the profits and the quality of the
company make it seem worth a lot more than what the market thinks. A stock picker
carefully purchases securities based on a sense that they are worth more than the market
rise. When doing so, he faces two kinds of risks:
1. His understanding can be wrong, and the company is really not worth more than the
market price; or,
2. The entire market moves against him and generates losses even though the underlying
idea was correct.
However, there is a simple way out. Every time you adopt a long position on a security,
you should sell some amount of Nifty futures. This offsets the hidden Nifty exposure that
is inside every long–security position.
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Hedging: Short security, long Nifty futures
Investors studying the market often come across a security which they believe is
intrinsically over-valued. It may be the case that the profits and the quality of the
company make it worth a lot less than what the market thinks. A stock picker carefully
sells securities based on a sense that they are worth less than the market price. In doing so
he faces two kinds of risks:
1. His understanding can be wrong, and the company is really worth more than the
market price; or,
2. The entire market moves against him and generates losses even though the underlying
idea was correct.
Every time you adopt a short position on a security, you should buy some amount of
Nifty futures. This offsets the hidden Nifty exposure that is inside every short–security
position. Once this is done, you will have a position which is purely about the
performance of the security.
SPECULATION
Speculation is a strategy in which a position is taken on the future movement in the prices
of the shares. Previously mutual funds were not permitted to speculate in the derivatives
market. They were allowed to use derivatives only for the purpose of hedging. But with
the recent amendment in the regulations by Sebi, mutual funds can also use the
opportunity of speculating in derivatives.
A fund manger may have a view that markets are going to rise and that he can benefit by
taking a position on the index. Based on his view, he can buy Nifty futures and hold on to
that position until the price rises to his expected level. If the fund manager's view about
the market proves to be correct (i.e. the market rises), the fund will make a profit on its
Nifty future position.
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On the contrary, if his view proves incorrect then the fund will end up making a loss.
Conversely, if a fund manager feels bearish about the market, he will sell Nifty futures
and will hold on to it until the markets moved southwards. Similarly, the fund manager
can also speculate in individual stocks by buying or selling stock futures/options
Speculation in derivatives is a double-edged sword, i.e. there exists a possibility of

making profits or incurring losses based on how the fund manager's call pans out.
Speculation can be done on both futures and options (Call & Put).
Though futures have potentially unlimited upside and downside, the payoff for options is
a bit unique. For the buyer of the option, the loss is limited to the premium whereas for
the seller it is unlimited.
ARBITRAGE
Arbitrage is a strategy, which involves simultaneous purchase and sale of identical or

equivalent instruments in two or more markets in order to benefit from a discrepancy in
pricing. This strategy normally acts as a shield against market volatility as the buying and
selling transactions offset each other.
Recently UTI Mutual Fund and JM Mutual Fund have launched arbitrage funds, which
will employ the arbitrage strategy of buying in cash and simultaneously selling in futures
market.
In an arbitrage transaction, returns are calculated as the difference between the futures
price and cash price at the time of the transaction. Ideally the positions are held till the
expiry of the futures contract when the offsetting positions cancel each other and initial
price difference is realised.
This arbitrage strategy makes the fund immune to market volatility i.e. the fund will not
be affected by market fluctuations. Since the portfolio of arbitrage funds is completely
hedged at all times to lower the risk of loss/erosion of gains, it also in turn caps the
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returns that the fund could have clocked if the portfolio was unhedged i.e. these funds
have a limited upside.
Despite the fact that arbitrage funds offer investors the opportunity to benefit from
investments in equities by making use of derivatives, the fund cannot be compared to
conventional diversified equity funds, especially on the returns parameter.
The returns from arbitrage funds would typically be much lower than those of equity
funds. That could be one reason why despite their equity holdings, arbitrage funds are
benchmarked against indices like CRISIL Liquid Fund Index for want of a more
appropriate index.
Apart from the strategies mentioned here, there are more complex derivative strategies,
which can be used by mutual funds. The strategy would depend mainly on the prevailing
market condition.
From the investor's perspective, investing in a mutual fund that dabbles in derivatives
should not be considered as a sure shot way to generate/enhance returns.
While hedging and arbitrage strategies, when used effectively, can make the fund's
portfolio immune to market volatility, using derivatives for speculation holds the
possibility of converting the fund into a typical high risk -- high return investment
proposition.
2.4. OPTIONS
An option is a contractual agreement that gives the holder the right to buy (call option) or
sell (put option) a fixed quantity of a security or commodity (for example, a commodity
or commodity futures contract), at a fixed price, within a specified period of time. May
either be standardized, exchange-traded, and government regulated, or over-the-counter
customized and non-regulated.
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The seller of the option grants the buyer of the option the right to purchase from, or sell
to, the seller a designated instrument at specified price within a specified period of time.
If the option buyer exercises that right, the option seller is obligated.
The seller (known as the writer) grants this right to the buyer in exchange for a sum of
money called the option premium. The option premium is effectively the price of the
option.
The price at which the underlying instrument may be bought or sold is called the exercise
or strike price. The date after which the option is no longer active is called the expiration
date. In India we follow ‘European-style’ option .Here the option may be exercised only
on the expiration date.
Call Options: Profit and loss

If you buy an options contract you are buying the option, or "right" to trade a particular
underlying instrument at a stated price.
An option that gives you the right to eventually make a purchase at a predetermined price
is called a "call" option. If you buy that right it is called a long call; if you sell that right it
is called a short call. An option that gives you the right to eventually make a sale at a
predetermined price is called a "put" option. If you buy that right it is called a long put; if
you sell that right it is called a short put.
A profit/loss graph shows, as the name suggests, the potential profit and loss inherent in a
particular option position. We will start with call options. Suppose a call option with an
exercise/strike price equal to the price of the underlying (100) is bought today for Rs1.
At expiry, if the security’s price has fallen below the strike price, the option will be
allowed to expire worthless and the position has lost Rs1. This is the maximum amount
that you can lose because an option only involves the right to buy or sell, not the
obligation. In other words, if it is not in your interest to exercise the option you don’t
have to and so – if you are an option buyer – your maximum loss is the premium you
have paid for the right.
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If, on the other hand, the security’s price rises, the value of the option will increase by
Rs1 for every Rs1 increase in the security’s price above the strike price (less the initial
Rs1 cost of the option).
Note that if the price of the underlying increases by Rs1, the option purchaser breaks
even - breakeven is reached when the value of the option at expiry is equal to the initial
purchase price. For our call option, the breakeven price is 101. If the price of the security
is greater than 101, the call buyer makes money.
Now look at the profit/loss for a short call.
Here profit is limited to the premium received for selling the right to buy at the exercise
price - again Rs1. For every Rs1 rise in the price of the underlying security above the
exercise price the option falls in value by Rs1. Here again, the breakeven point is 101.
Put Options: Profit and loss
A put is the reverse of a call in that the value of the position rises as the price of the
underlying security falls. Here is the profit/loss graph for a long put.
At expiry the put is worth nothing if the security’s price is more than the strike price of
the option but, as with the long call, the option buyer’s loss is limited to the premium
paid. The breakeven for this option is 99, so the put purchaser makes money if the
underlying security is priced below 99 at expiry. And here is the profit/loss graph for a
short put.
Here profit is limited to the premium received for selling the right to sell at the strike
price. For every Rs1 fall in the price of the underlying security below the strike price the
option falls in value by Rs1. Here again, the breakeven point is 99.
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3. HEDGING MUTUAL FUNDS
3.1. Hedging
What is Hedging :
Hedging is a mechanism to reduce price risk inherent in open positions. Derivatives are
widely used for hedging. A Hedge can help lock in existing profits. Its purpose is to
reduce the volatility of a portfolio, by reducing the risk. It needs to be noted that
hedging does not mean maximization of return. It only means reduction in variation of
return. It is quite possible that the return is higher in the absence of the hedge, but so also
is the possibility of a much lower return.
It is the responsibility of the portfolio managers to reduce their exposure of risks, if there
is any fall in the price. This can be done in several ways. Simply selling the stock and
repurchasing it late is one way. But this strategy involves substantial costs. It is relatively
expensive to buy and sell stock because of the transaction costs in the form of bid-ask
spreads and commissions. Again trading in large amount of stock can influence the
market, resulting in poor realization of prices.
There is other alternative to solve this issue, which is called hedging. Hedging with
futures basically involves taking a position in futures as a temporary alternative for
transactions to be executed in the cash market. The primary objective of hedging is to
avoid price risk by trying to fix the price of the transaction to be made at a later date. If
cash and future prices move together, any loss realized in one market will be
compensated by the profit in other markets. When the profit and loss from each position
are equal, the hedge is said to be perfect.
The liquidity of stock index futures has made them the market’s choice especially for
institutional investors. When using stock index futures to reduce stock market risk, the
anticipation is that any losses arising from movements in stock prices are offset by gains
from parallel movement in future prices.
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A portfolio manager might be worried about the possibility that the decline in the value
of the portfolio by taking position in the future market that would provide a gain in the
event of a fall in stock prices. In such a case, the short position, fund manager ensures a
notional selling price of a quantity of stock for a specific date in future. Should stock
prices fall and stock index futures behave in a corresponding manner, the notional buying
price on that date would be less than his/her position in futures by taking a long position
in the same number of the contracts. The excess of selling price over the buying price is
paid out to the portfolio manager.
On the other hand, if the stock prices had increased, then the portfolio manager would
have gained from his/her portfolios of equities but lost on future dealings. In either case,
the portfolio manager would have succeeded in reducing the extent to which the value of
the portfolio fluctuates. The major advantage in using index futures is to hedge the risk of
a fall in the stock prices without any alteration in the original portfolio.
Let us work out an example to understand this concept. Fund manager holds a balanced
portfolio of equities valued at Rs. 1,00,00,000 on April 5, but fears a fall in its value due
to general fall in equity prices. Assume that the benchmark index on which futures are
being traded is at 500 and futures contracts trade at multiple of 500 times the index and
so to hedge the portfolio the fund manager has to sell 40 June contracts at a price of 500
each. He has thus committed himself to the notional sale of Rs.1.00.00.000 of the stock
on the June delivery date at the level of equity prices implied by the futures on April 5,
(40 x 500 x 500 = Rs. 1,00,00,000).
In a practical situation, hedging may not be as perfect as above because the amount of the
loss and profit from each position may not be equal. The real outcome of a hedge will
depend on the relationship between the cash price and futures price when hedge is
entered into and when it is squared off.
The difference between the cash price and future price is called the basis. The risk that
the change in basis will not be favorable is known as basis risk. In most of hedging
applications, the asset to be hedged is not identical to the asset underlying the future
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contract. This type of hedging is referred as cross hedging in which the characteristics of
the spot and future position do not match perfectly. In this type of hedging one can expect
a lot of exposure to the basis risk. An unhedged position in any asset is exposed to price
risk, while a hedged position replaces the price risk with basis risk.
In the case of declining cash price of fixed income securities resulting form the increase
in the interest rate, futures on fixed instruments should be sold (short). The hedged
position can fix the cash price to be realized later and can also transfer the price risk of
ownership to the buyer of the futures contract. Considering that the effectiveness of the
hedge depends on the movement of basis, it is possible to assess the size of position to be
taken in futures so as to minimize the impact of basis risk if not to eliminate it.
On the other hand, to protect against an increase in cash price of the fixed income
instrument resulting from the decline in interest rate, futures on that fixed income security
should be purchased (long hedge). By establishing a long hedge, the hedger is locking in
a purchaser price. A long hedge will be used when substantial cash contribution is
expected and investor will expect interest rate to decline. Again to lock in the interest
rate, long hedge can be used when the bonds are maturing in near future and interest rates
are expected to fall.
General Hedging Strategies
One of the popular strategies for hedging is : "If you are long in cash underlying - Short
Future; and If short in cash underlying - Long Future".
This can be illustrated by a simple example. If one has bought 100 shares of say Reliance
Industries and want to Hedge against market movements, he has to short an appropriate
amount of Index Futures. This will reduce his overall exposure to events affecting the
whole market (systematic risk).
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Suppose a major terrorist attack takes place, the entire market can sharply fall. In such a
case, his in Reliance Industries would be offset by the gains in his short position in Index
Futures.
Some other examples of where hedging strategies that can be really useful can be as
follows :-
· Reducing the equity exposure of a Mutual Fund by selling Index Futures;

· Investing funds raised by new schemes in Index Futures so that market
exposure is immediately taken; and
· Partial liquidation of portfolio by selling the index future instead of the actual
shares where the cost of transaction is higher
3.2. Activities of Fund-Houses
We had already seen the applicability of index futures in portfolio, but fund-houses are
not very keen in using strategy. Generally, fund-houses are not concerned about the
short-term fluctuations, as they are more concerned about long-term objectives and in the
NAVs. However, retail investors are typically short sighted in their investment
objectives. A fund that has performed well in the last couple of months is perceived as
one that will do just as well in the future. Hence, portfolio manager would tend to invest a
proportion of the portfolio in momentum stocks that are expected to increase sharply in
the near term. Further, to continue, the fund should construct appropriate hedging
strategy to ensure that the portfolio is not affected in the short-term.
For instance, a fund may choose to hedge only 50 per cent of its total portfolio or to
hedge only the stocks that are considered momentum plays. This could entail
differentiating the assets into trading and investment portfolio. However, portfolio
managers do not seem to have a hedging strategy in their portfolios, as they do not have a
position in the derivatives market.
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Although, portfolio managers use value-at-risk models to control risk is not the same as
hedging. Such risk models attempt to control the portfolio risk by managing the exposure
in the spot market. Hedging, on the other hand, refers to taking a derivatives position that
is contrary to the one in the spot market.
Further, SEBI has clarified that mutual funds are permitted to hedge by taking positions
contrary to their exposure in the spot market. Fund-houses are not in apposition to
defend themselves by stating that the investment objectives do not provide for such
hedging. Most funds that were started way before derivatives trading was introduced in
India now have unit-holders' approval to construct a hedging programme.
3.2.1. What kind of risk needs to be hedged?
If a mutual fund holds substantial shares of that company's stock, it may have to consider
hedging its position against such an event risk. The reason behind this is the stock may
have sparkled up in anticipation of a favorable verdict from the USFDA. On the other
hand, if the ruling is adverse, the stock may experience a steep decline in its value. Thus,
portfolio management demands that mutual funds construct a hedging system to reduce
short-term decline in NAVs. This would emphasize the need to construct the portfolio in
the backdrop of a short-term and long-term risk-return matrix.
3.3. Risk Management and the Mutual Funds
The objective of a mutual fund is to provide a diversified portfolio that reduces the risk in
investments at a lower cost. Investors who take up mutual fund route for investments
believe that their risk is minimized at lower costs, and they get an optimum portfolio of
securities that match their risk appetite. However, investors are ignorant about the diverse
techniques and hedging products that can be used for minimizing the market volatility
and hence take the help of the fund managers.
In some cases, the drop in NAV of some of the schemes is higher than the decline of
value in some of the Information, Communication and Entertainment stocks. The recent
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survey conducted by PricewaterhouseCoopers (PWC) on risk management by mutual

funds has posted some interesting as well as worrying results. According to the survey
published by PWC, 50 percent of the respondent mutual funds are not managing risk
properly and remaining 50 percent of the respondents did not even have documented risk
procedures or dedicated risk managers. The respondents included among others are some
of the heavyweights of the Indian MF industry viz. Templeton, Alliance, Prudential and
IDBI Principal MF.
The recent volatile movements in the NAVs of several equity funds have disproved all
expectation of a diversified portfolio from the fund managers when the basic tenet behind
portfolio management is risk management. Further, no fund managers are trying to use
derivatives in their portfolio and this is clearly visible from the following statement.
3.4. Hedging minimizes the risk of portfolio
There are times when an investor should consider re-balancing portfolio to minimize risk.
When the stock market is particularly volatile, or when an investor is nearing retirement,
it becomes more important to protect assets than to go for risky growth. The objective of
hedging is to reduce the risk of the extent to which the portfolio is exposed. The risk is
reduced by making an additional investment, whose risk cancels out the initial risk. Let
us understand this with an example, a mutual fund manager holds assets worth Rs. 50
crores. Fund Manager feels that the market is in highly volatile condition and it might
drop in near future, so to protect his fund, he could uses the following strategies
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Liquidate a portion of the assets and hold cash
Sell index futures equal to the value of the portfolio
In the latter case, the benefit of using index futures becomes apparent. Using the first
strategy means the portfolio manager has to liquidate a portion of his assets. Normally, as
the risk is greater in a falling market, his ability to get a good price when selling is
remote. Normally, in such circumstances, the fund manager is forced to sell some of his
premium holdings. For instance, the UTI, which had to sell large volumes of Hindustan
Lever and ITC to meet dividend payments under the US-64.
Further, all the stocks in the portfolio may be solid ones, which would generate excess
returns over the long term. On the other hand, by using index futures, the fund manager
can avoid the need to sell individual stocks. At the same time, he can cover the value of
the portfolio against any adverse movement in prices.
Making the perfect hedge, where the manager can completely cover his market risk, is
important as the portfolio gets strengthened. But this may not be a good strategy as it will
generate only the risk-free rate of return. Traditional capital market theory states that
investors are rewarded for the market risk component in their portfolios.
By executing a perfect hedge, market risk is completely eliminated, thereby not earning
excess return. However, in practice, finding a perfect hedge is not a possible. An
important characteristic of a perfect hedge is that the movement of the portfolio must be
perfectly correlated with the movement of the underlying index.
Uses of index futures
Fund managers can use index futures in these ways:

Portfolio performance can be segregated into two portions based on stock selection and
market timing. Stock selection relates to the ability of the fund manager to spot stocks
that are mispriced, while market timing is concerned with his ability to forecast market
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movements. Let us envisage a situation where a fund manager identifies a share that is
underpriced but has a high beta value.
Assuming that the market may fall, the fund manager is in a fix. From the point of view
of stock selection the decision warrants going long on the stock but market timing
suggests otherwise. This is where the use of index futures to control beta plays a crucial
role. Effectively, index futures permit control of the riskiness of the portfolio without
hindering the stock selection decision.
Another important aspect where index futures help is in asset allocation. Returns for a
fund depend on the right level of diversification and the choice of assets used to diversify.
If there arises a situation where the asset manager is able to identify a different set of
assets which would improve the fund's performance, what should he do?
He has two options: The first is to liquidate the existing asset position and the next is to
purchase a new set of assets. As such a process requires time, managers can immediately
lock in on the returns by using corresponding futures contracts.
With uncertain volatility, funds face problems in terms of redemptions. In the absence on
index futures, funds have to invest the money in short-term deposits and other highly
liquid instruments. However, the return earned on such assets is lower than those on
equity investments. With the introduction of futures, fund managers have a highly liquid
option, providing a higher rate of return, in which they can invest their excess funds.
The role of foreign institutional investors in the Indian market has been
critical in the recent past. The introduction of index futures as a hedging mechanism may
actually attract more foreign funds into the country by way of FII investments. An
investor who invests in foreign markets is exposed to two sources of risk -- market risk
and the foreign exchange risk associated with the country.
When the position is liquidated, the proceeds are converted to the home currency of the
international investor at the prevailing exchange rate. By taking an opposite position in
the futures market, the investor's risks are confined to margin payments and receipts
which would be much lower than the actual position in the stocks.
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4. REGULATORY FRAMEWORK
Use of derivatives by mutual funds
Mutual funds should be allowed to use financial derivatives for hedging purposes
(including anticipated hedging) and portfolio re-balancing within a policy framework and
rules laid down by their Board of Trustees who should specify what derivatives are
allowed to be used, within what limits, for what purposes, for which schemes, and also
the authorisation procedure.
“The offer documents of mutual fund schemes should disclose whether the scheme
permits the use of derivatives and the details in this regard. Also the income and.32
balance sheet of each mutual fund scheme would have to disclose the impact of
derivatives trading and of any open position in this regard.”
New Schemes: Utilising mainstream governance and disclosure mechanisms

Under normal circumstances, the trading strategies and ideas in portfolio management
used by the AMC should be fully disclosed in the offer document, and the AMC should
be closely interacting with the trustees who perform governance functions on behalf of
investors on all aspects of the operations of the scheme. In this environment, the role of
SEBI is limited to certain improvements in disclosure norms, using which mutual funds
would give investors and potential investors sound information about the portfolio
strategies associated with a given scheme.
Hence, the first mechanism through which mutual fund schemes can engage in
derivatives trading consists of three steps:
Additional text in the prospectus which fully explains the ways in a given scheme would
use financial derivatives, including numerical examples,
An ongoing dialogue with the trustees, whereby the trustees would establish that the
actual functioning of the AMC is consistent with these promises,
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By these principles, if a mutual fund house can persuade investors that a beta=5
leveraged equity index fund is an attractive product, and thus raise resources which
should be deployed through such a strategy, then it should be free to implement this using
index futures and/or index options.
This path can be utilised when new schemes are created. For existing mutual fund
schemes, utilising this path involves a modification to the offer document, which entails
obtaining the consent of existing unit-holders.
Existing Schemes: Rules governing hedging and portfolio rebalancing.
The bulk of mutual fund assets today are in existing open-end schemes. It is likely that
the bulk of new resources coming into mutual funds in the future will come into open-end
schemes that exist as of today. In the absence of any changes to a mutual fund prospectus,
the rules governing derivatives trading by mutual funds should limit mutual funds to
certain strategies:
Portfolio rebalancing
Hedging
6.2.1 What does hedging mean?
The term hedging is fairly clear. It would cover derivative market positions that are
designed to offset the potential losses from existing cash market positions. Some
examples of this are as follows:
An income fund has a large portfolio of bonds. This portfolio stands to make losses when
interest rates go up. Hence, the fund may choose to short an interest rate futures product
in order to offset this loss.
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An income fund has a large portfolio of corporate bonds. This portfolio stands to make
losses when credit spreads of these bonds degrade or when defaults take place. Hence, the
fund may choose to buy credit derivatives which pay when these events happen.
Every equity portfolio has exposure to the market index. Hence, the fund may choose to
sell index futures, or buy index put options, in order to reduce the losses that would take
place in the event that the market index drops.
The regulatory concerns are about (a) the effectiveness of the hedge and (b) its size.
“Hedging” a Rs.1 billion equity portfolio with an average beta of 1.1 with a Rs. 1.3
billion short position in index futures is not an acceptable hedge because the over hedged
position is equivalent to a naked short position in the future of Rs. 0.2 billion. Similarly,
“hedging” a diversified equity portfolio with an equal short position in a narrow sectoral
index would not be acceptable because of the concern on effectiveness. A hedge of only
that part of the portfolio that is invested in stocks belonging to the same sector of the
sectoral index by an equal short position in the sectoral index futures would be
acceptable.
“Hedging” an investment in a stock with a short position in another stocks’ futures is not
an acceptable hedge because of effectiveness concerns. This would be true even for
merger arbitrage where long and short positions in two merging companies are combined
to benefit from deviations of market prices from the swap ratio.
Hedging with options would be regarded as over-hedging if the notional value of the
hedge exceeds the underlying position of the fund even if the option delta is less than the
underlying position. For example, a Rs.2 billion index put purchased at the money is not
an acceptable hedge of a Rs.1 billion, beta=1.1 fund though the option delta of
approximately Rs. 1 billion is less than the underlying exposure of the fund of Rs. 1.1
billion.
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Covered call writing is hedging if the effectiveness and size conditions are met. Again the
size of the hedge in terms of notional value and not option delta must not exceed the
underlying portfolio.
The position is more complicated if the option position includes long calls or short puts.
The worst-case short exposure considering all possible expiration prices (see 6.2.3 below)
should meet the size condition.
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5. DATA ANALYSIS AND PRESENTATION
The purpose of this study is to understand and identify the effectiveness of using
derivatives in the Mutual Funds. For this purpose, I have taken Franklin Templeton
Investments in the Mutual category and S&P CNX Nifty, CNX IT in the F&O segment.
Further, this study is done for the period between May 2, 2008 and May 24, 2008. The
basic reason behind choosing this period is to identify the effectives of hedging in the
short term horizon. I have taken three equity related schemes for the study and they are as
follows
1. Franklin Bluechip Fund – Growth
2. Franklin Infotech Fund – Growth
3. Franklin India Prima Fund – Growth
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5.1. Franklin Bluechip Fund
Investment Objective: The objective of this fund is to maintain the steady and consistent
growth by focusing on well-established and large size companies. Further, the fund aims
to provide medium to long term capital appreciation.
*Portfolio composition is as of APRIL 30, 2008
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STEP 1:
• Calculation of market lots to be sold in the futures market:
Ascertain of Market Lot

in millions
Total Asset Value (April 30, 2008) 23681
Beta 1
Complete Hedge 23681
50% Hedge 11840.5
Nifty on 2-May 3595

Market lot 100
Cost of 1 ML 359500
1 0.3595
? 11840.5
Total Market Lot 32936.02
NAV on April 30, 2008:
NAV Total Units (in millions)

117.36 201.7808453
To have 50% Hedge, the fund manager has to sell 32,936 nifty futures
*Note: NAV means Net Asset Value
STEP 2:
• Calculation of mutual fund returns
No of Units: 201.78
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Date Total Assets NAV Daily Returns

(in millions)
2-May-08 24431.62 121.08
3-May-08 24480.05 121.32 0.198
4-May-08 24643.49 122.13 0.668
5-May-08 24695.96 122.39 0.213
8-May-08 24708.05 122.44 0.041
9-May-08 24829.13 123.05 0.498
10-May-08 24887.65 123.34 0.236
11-May-08 24625.33 122.04 -1.054
12-May-08 24429.61 121.07 -0.795
15-May-08 23495.36 116.44 -3.824
16-May-08 23475.18 116.34 -0.086
17-May-08 23878.75 118.34 1.719
18-May-08 22431.98 111.17 -6.059
19-May-08 21628.89 107.19 -3.580
22-May-08 20589.72 102.04 -4.805
23-May-08 21318.15 105.65 3.538
24-May-08 20878.26 103.47 -2.083
Returns for the period -14.544
Interpretation for steps 1 and 2:
The first and foremost step is to identify the number of market lots to be sold in the
futures market. For this purpose, we require the total asset value of the portfolio. As the
study is done for the period between May 1, 2008 and May 24*, 2008, the TAV on May
2 will be equivalent to closing TAV of April 2008. After finding the TAV, fund manager
has to decide the proportion to hedge and this is not constant for all the schemes, as the
risks are suppose to vary according to the nature of the scheme. In this case I have
assumed to hedge 50% of the TAV and calculated the number of market lots accordingly.
The result was to short 32,936 futures contract.
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In the next step, I have calculated the mutual fund returns for both daily and for the
period. The above calculated unhedged mutual fund returns yielded the negative returns
of 14.5%. If the fund manager had used the futures market to hedge the mutual fund
returns, he could have minimized the risk. Lets us see an example of the same scheme,
which used the hedging strategy.
*The futures contract expiry date was May 25, 2008 and that was the reason for selecting
May 24, 2008 as a closing date, thus allows the fund manager to offset his position.
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STEP: 3
• Short 32, 936 nifty futures on May 2, 2008
Date Nifty futures Difference Market Profit/Loss

Lot (in millions)
32,936
2-May-08 3595
3-May-08 3612.4 17.4 -57.31
4-May-08 3627.4 15 -49.40
5-May-08 3644.1 16.7 -55.00
8-May-08 3685.85 41.75 -137.51
9-May-08 3712.95 27.1 -89.26
10-May-08 3745.4 32.45 -108.88
11-May-08 3692.9 -52.5 172.91
12-May-08 3633 -59.9 197.29
15-May-08 3462.05 -170.95 563.04
16-May-08 3520.3 58.25 -191.85
17-May-08 3641.25 120.95 -398.36
18-May-08 3363.85 -277.4 913.64
19-May-08 3224.35 -139.5 459.46
22-May-08 3020.9 -203.45 670.08
23-May-08 3190.5 169.6 -558.59
24-May-08 3087.25 -103.25 340.08
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Interpretation for step 3:
Fund manager entered the futures market to minimize the portfolio risks. As per the
strategy, if you long portfolio, then short index futures. In this case, the schemes
underlying index is S&P CNX Nifty. So the fund manager has to short a certain number
of contracts to cover his portfolio risks. As per assumption, fund manager has gone 50%
hedge with portfolio beta of 1, therefore the total asset value multiplied by beta value to
give hedging proportion. Then the difference was calculated for the day to days
movements to find out the profit or loss for the transaction.
STEP 4:
• Adjustment of futures contract profit or loss in mutual funds TAV to ascertain the
adjusted NAV
In this step, before adjusting the total profit or loss in TAV, it is necessary to ascertain the
daily difference in TAV, which has been calculated with the help of multiplying number
of units with daily NAV. Then the ascertained difference in TAV was adjusted with
profit or loss in the futures contract to find out the adjusted TAV.
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Date TAV Difference P/L* in futures Total P/L Adjusted

(in millions) in TAV contract TAV
(in millions)
2-May-08 24431.62 24431.62
3-May-08 24480.05 48.43 57.31 -8.88 24422.74
4-May-08 24643.49 163.44 49.40 114.04 24536.78
5-May-08 24695.96 52.46 55.00 -2.54 24534.24
8-May-08 24708.05 10.09 137.51 -127.42 24408.82
9-May-08 24829.13 123.09 89.26 33.83 24440.65
10-May-08 24887.65 58.52 108.88 -48.36 24392.29
11-May-08 24625.33 -262.32 -172.91 -89.40 24302.89
12-May-08 24429.61 -195.73 -197.29 1.56 24304.45
15-May-08 23495.36 -934.25 -563.04 -371.20 23933.25
16-May-08 23475.18 -20.18 191.85 -212.03 23721.22
17-May-08 23878.75 403.56 398.36 5.20 23726.42
18-May-08 22431.98 -1446.77 -913.64 -533.12 23193.29
19-May-08 21628.89 -803.09 -459.46 -343.63 22849.66
22-May-08 20589.72 -1039.17 -670.08 -369.09 22480.57
23-May-08 21318.15 728.43 558.59 169.83 22650.41
24-May-08 20878.26 -439.88 -340.08 -99.82 22550.59
*Note: P/L denotes profit or loss
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STEP 5:
• Calculation of adjusted NAV and ascertainment of hedged returns
Date Adjusted TAV NAV Hedged daily

returns
2-May-08 24431.62 121.08
3-May-08 24422.74 121.036 -0.036
4-May-08 24536.78 121.6011 0.467
5-May-08 24534.24 121.5886 -0.010
8-May-08 24408.82 120.9571 -0.519
9-May-08 24440.65 121.1247 0.139
10-May-08 24392.29 120.8851 -0.198
11-May-08 24302.89 120.442 -0.367
12-May-08 24304.45 120.4497 0.008
15-May-08 23933.25 118.6101 -1.527
16-May-08 23721.22 117.5593 -0.886
17-May-08 23726.42 117.5851 0.022
18-May-08 23193.29 114.943 -2.247
19-May-08 22849.66 113.24 -1.482
22-May-08 22480.57 111.4108 -1.615
23-May-08 22650.41 112.2525 0.755
24-May-08 22550.59 111.7578 -0.441
Graphical representation of hedged and unhedged returns:
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Daily Returns
H-NAVr
-2
-4
-6
-8
2- 3- 4- 5- 8- 9- 10- 11- 12- 15- 16- 17- 18- 19- 22- 23- 24-
May- May- May- May- May- May- May- May- May- May- May- May- May- May- May- May- May-
08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08
*Note: H-NAVr means Hedged returns (Daily)
In this step, we ascertained the hedged daily returns, which came to -7.70%. this clearly
shows the effectiveness of hedging. The unhedged mutual fund yielded the negative
return of -14.54%. Therefore, with the use of hedging strategy, fund manager can reduce
their risk exposure and in the above case around 50% of the market risk was eliminated
with the help of hedging. Additionally, the above chart depicts the reduction in risk,
which is compared with the unhedged ones. However, on May 23, 2008, unhedged
returns were high but in a overall scenario, hedging proved to be more effective.
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Chi-Square Test
Null Hypothesis: Mutual Funds Returns = Hedge Funds Returns

Alternative Hypothesis: Mutual Funds Returns not equal to Hedge Funds Returns
Mutual Funds Hedge Funds

Returns Returns
0.198 -0.036
0.668 0.467
0.213 -0.010
0.041 -0.519
0.498 0.139
0.236 -0.198
-1.054 -0.367
-0.795 0.008
-3.824 -1.527
-0.086 -0.886
1.719 0.022
-6.059 -2.247
-3.580 -1.482
-4.805 -1.615
3.538 0.755
-2.083 -0.441
Result: By using Chi-square test, the Value of x square is 7.58 that are more than table
value i.e. 6.262 @ 5 % significance level. So Null Hypothesis is rejected it means the
hedging funds returns are not equal to mutual funds returns
5.2. Franklin Infotech Fund
Investment Objective: The objective is to focus on companies in the information

technology sector and to provide long term capital appreciation by investing primarily in
Information Technology industry.
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* Portfolio Composition as of April 30, 2008
STEP 1:
Ascertainment of Market Lot

in millions
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Total Asset Value (April 30, 2008) 1602.4

Beta 0.88
Complete Hedge 1410.112
50% Hedge 705.056
Nifty on 2-May 4373.2

Market lot 100
Cost of 1 ML 437320
1 0.43732
? 705.056
Total Market Lot 1612.22

41.68 38.45
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STEP 2:

Number of Units: 38.45 (in millions)
Date TAV NAV Daily

(in millions) Returns
2-May-08 1618.16 42.09
3-May-08 1633.93 42.5 0.974
4-May-08 1643.92 42.76 0.612
5-May-08 1639.69 42.65 -0.257
8-May-08 1649.30 42.9 0.586
9-May-08 1652.38 42.98 0.186
10-May-08 1661.61 43.22 0.558
11-May-08 1648.15 42.87 -0.810
12-May-08 1638.92 42.63 -0.560
15-May-08 1597.02 41.54 -2.557
16-May-08 1593.56 41.45 -0.217
17-May-08 1625.85 42.29 2.027
18-May-08 1543.58 40.15 -5.080
19-May-08 1491.29 38.79 -3.387
22-May-08 1422.48 37 -4.615
23-May-08 1468.23 38.19 3.216
24-May-08 1445.93 37.61 -1.519
Monthly Returns -10.64
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of -10.64%. If the fund manager had used the futures market to hedge the mutual fund
* The futures contract expiry date was May 25, 2008 and that was the reason for selecting
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STEP: 3
• Short 1,612 CNX IT futures on May 2, 2008
Date CNX IT futures Difference Market Profit/Loss

Lot (in millions)
1,612
2-May-08 4373.2
3-May-08 4410.75 37.55 6.05
4-May-08 4413 2.25 0.36
5-May-08 4401.35 -11.65 -1.88
8-May-08 4425 23.65 3.81
9-May-08 4452.25 27.25 4.39
10-May-08 4448.3 -3.95 -0.64
11-May-08 4416 -32.3 -5.21
12-May-08 4391.9 -24.1 -3.88
15-May-08 4292 -99.9 -16.10
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16-May-08 4322.35 30.35 4.89

17-May-08 4414.6 92.25 14.87
18-May-08 4119.85 -294.75 -47.51
19-May-08 4005 -114.85 -18.51
22-May-08 3725.9 -279.1 -44.99
23-May-08 3921.95 196.05 31.60
24-May-08 3814.55 -107.4 -17.31
underlying index is CNX IT. So the fund manager has to short a certain number of
contracts to cover his portfolio risks. As per assumption, fund manager has gone 50%
hedge with portfolio beta of 0.88, therefore the total asset value multiplied by beta value
to give hedging proportion. Then the difference was calculated for the day to day
STEP 4:
adjusted NAV
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Date TAV Differenc P/L Total P/L Adjusted TAV

(in millions) e (in millions) (in millions) (in millions)
in TAV
2-May-08 1618.16 1618.16
3-May-08 1633.93 15.76 6.05 9.71 1627.87
4-May-08 1643.92 10.00 0.36 9.63 1637.51
5-May-08 1639.69 -4.23 -1.88 -2.35 1635.15
8-May-08 1649.30 9.61 3.81 5.80 1640.95
9-May-08 1652.38 3.08 4.39 -1.32 1639.64
10-May-08 1661.61 9.23 -0.64 9.86 1649.50
11-May-08 1648.15 -13.46 -5.21 -8.25 1641.25
12-May-08 1638.92 -9.23 -3.88 -5.34 1635.91
15-May-08 1597.02 -41.91 -16.10 -25.80 1610.11
16-May-08 1593.56 -3.46 4.89 -8.35 1601.75
17-May-08 1625.85 32.29 14.87 17.42 1619.18
18-May-08 1543.58 -82.27 -47.51 -34.76 1584.42
19-May-08 1491.29 -52.29 -18.51 -33.77 1550.65
22-May-08 1422.48 -68.82 -44.99 -23.83 1526.82
23-May-08 1468.23 45.75 31.60 14.15 1540.97
24-May-08 1445.93 -22.30 -17.31 -4.99 1535.98
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STEP 5:
Date Adjusted NAV Hedged daily

TAV returns
2-May-08 1618.16 42.09
3-May-08 1627.87 42.34255 0.600
4-May-08 1637.51 42.59312 0.592
5-May-08 1635.15 42.53197 -0.144
8-May-08 1640.95 42.6828 0.355
9-May-08 1639.64 42.64855 -0.080
10-May-08 1649.50 42.90511 0.602
11-May-08 1641.25 42.69054 -0.500
12-May-08 1635.91 42.55159 -0.325
15-May-08 1610.11 41.88047 -1.577
16-May-08 1601.75 41.66321 -0.519
17-May-08 1619.18 42.11641 1.088
18-May-08 1584.42 41.21229 -2.147
19-May-08 1550.65 40.33385 -2.131
22-May-08 1526.82 39.71411 -1.537
23-May-08 1540.97 40.08208 0.927
24-May-08 1535.98 39.9524 -0.324
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Daily Returns
-1
H-NAVr
-2
-3
-4
-5
-6
2- 3- 4- 5- 8- 9- 10- 11- 12- 15- 16- 17- 18- 19- 22- 23- 24-
08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08
In this step, we ascertained the hedged daily returns, which came to -5.07%. This clearly
return of -10.64%. Therefore, with the use of hedging strategy, fund manager can reduce
which is compared with the unhedged ones.
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Chi-Square Test


Returns Returns
0.974 0.600
0.612 0.592
-0.257 -0.144
0.586 0.355
0.186 -0.080
0.558 0.602
-0.810 -0.500
-0.560 -0.325
-2.557 -1.577
-0.217 -0.519
2.027 1.088
-5.080 -2.147
-3.387 -2.131
-4.615 -1.537
3.216 0.927
-1.519 -0.324
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5.3. Franklin India Prima Fund
Investment Objective: The objective is to focus primarily on mid and small cap
companies. Further, aims to provide long term capital appreciation as primary objective
and income as secondary objective.
*Portfolio Composition is as of April 30, 2008
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The underlying index for this fund is S&P CNX 500 index and it is not trading in the
derivatives m market. Therefore, I have ascertained the three months returns for both the
fund and Nifty and witnessed a perfect correlation, which came out be 0.94. So I have
used nifty futures to hedge the Franklin India Prima Fund’s portfolio.
STEP 1:
Ascertainment of Market Lot

in millions
Total Asset Value (April 30, 2008) 24,446
Beta 0.88
Complete Hedge 21,512.48
50% Hedge 12907.48
Nifty on 2-May 3595

Market lot 100
Cost of 1 ML 359500
1 0.3595
? 12907.48
Total Market Lot 35,904

203.46 120.15
STEP 2:

Number of Units: 38.45 (in millions)
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Date TAV NAV Daily returns

(in millions)
2-May-08 25144.08 209.27
3-May-08 25192.14 209.67 0.191
4-May-08 25354.34 211.02 0.644
5-May-08 25279.85 210.4 -0.294
8-May-08 25267.84 210.3 -0.048
9-May-08 25378.37 211.22 0.437
10-May-08 25410.82 211.49 0.128
11-May-08 25226.98 209.96 -0.723
12-May-08 25121.25 209.08 -0.419
15-May-08 24166.05 201.13 -3.802
16-May-08 24087.95 200.48 -0.323
17-May-08 24623.82 204.94 2.225
18-May-08 23361.03 194.43 -5.128
19-May-08 22590.86 188.02 -3.297
22-May-08 21523.92 179.14 -4.723
23-May-08 22131.88 184.2 2.825
24-May-08 22041.77 183.45 -0.407
Monthly Returns -12.34
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of 12.34%. If the fund manager had used the futures market to hedge the mutual fund
* The futures contract expiry date was May 25, 2008 and that was the reason for selecting
STEP: 3
• Short 35,904 Nifty futures on May 2, 2008
Date Nifty Difference Market Profit/Loss

futures Lot (in millions)
35,904
2-May-08 3595
3-May-08 3612.4 17.4 62.47
4-May-08 3627.4 15 53.86
5-May-08 3644.1 16.7 59.96
8-May-08 3685.85 41.75 149.90
9-May-08 3712.95 27.1 97.30
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10-May-08 3745.4 32.45 116.51

11-May-08 3692.9 -52.5 -188.50
12-May-08 3633 -59.9 -215.08
15-May-08 3462.05 -170.95 -613.78
16-May-08 3520.3 58.25 209.14
17-May-08 3641.25 120.95 434.26
18-May-08 3363.85 -277.4 -995.98
19-May-08 3224.35 -139.5 -500.86
22-May-08 3020.9 -203.45 -730.47
23-May-08 3190.5 169.6 608.93
24-May-08 3087.25 -103.25 -370.71
underlying index is S&P CNX Nifty. So the fund manager has to short a certain number
of contracts to cover his portfolio risks. As per assumption, fund manager has gone 60%
hedge with portfolio beta of 0.88, therefore the total asset value multiplied by beta value
to give hedging proportion. Then the difference was calculated for the day to day
STEP 4:
adjusted NAV
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Date TAV Difference P/L in Total P/L Adjusted

(in millions) in TAV Futures (in millions) TAV
contract
(in millions)
2-May-08 25144.08 25144.08

3-May-08 25192.14 48.08 62.47 -14.41 25129.67
4-May-08 25354.34 162.20 53.86 108.35 25238.02
5-May-08 25279.85 -74.49 59.96 -134.45 25103.56
8-May-08 25267.84 -12.02 149.90 -161.91 24941.65
9-May-08 25378.37 110.54 97.30 13.24 24954.89
10-May-08 25410.82 32.44 116.51 -84.07 24870.82
11-May-08 25226.98 -183.83 -188.50 4.66 24875.48
12-May-08 25121.25 -105.73 -215.08 109.33 24984.82
15-May-08 24166.05 -955.20 -613.78 -341.42 24643.39
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16-May-08 24087.95 -78.10 209.14 -287.24 24356.15

17-May-08 24623.82 535.88 434.26 101.62 24457.77
18-May-08 23361.03 -1262.79 -995.98 -266.81 24190.95
19-May-08 22590.86 -770.17 -500.86 -269.31 23921.64
22-May-08 21523.92 -1086.94 -730.47 -336.48 23585.17
23-May-08 22131.88 607.97 608.93 -0.97 23584.20
24-May-08 22041.77 -90.11 -370.71 280.60 23864.80
STEP 5:
Date Adjusted NAV Hedged Daily

TAV returns
2-May-08 25144.08 209.27

3-May-08 25129.67 209.15 -0.057
4-May-08 25238.02 210.0518 0.431
5-May-08 25103.56 208.9328 -0.533
8-May-08 24941.65 207.5852 -0.645
9-May-08 24954.89 207.6954 0.053
10-May-08 24870.82 208.9957 -0.337
11-May-08 24875.48 207.0345 0.019
12-May-08 24984.82 207.9445 0.440
15-May-08 24643.39 205.1029 -1.367
16-May-08 24356.15 202.7122 -1.166
17-May-08 24457.77 203.5579 0.417
18-May-08 24190.95 201.3373 -1.091
19-May-08 23921.64 199.0959 -1.113
22-May-08 23585.17 196.2954 -1.407
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23-May-08 23584.20 196.2874 -0.004

24-May-08 23864.80 198.6227 1.190
UH-NAVr
-1
H-NAVr
-2
-3
-4
-5
-6
2- 3- 4- 5- 8- 9- 10- 11- 12- 15- 16- 17- 18- 19- 22- 23- 24-
08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08 08
In this step, we ascertained the hedged daily returns, which came to -5.08%. This clearly
return of 12.34%. Therefore, with the use of hedging strategy, fund manager can reduce
which is compared with the unhedged ones.
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Chi-Square Test


Returns Returns
0.191 -0.057
0.644 0.431
-0.294 -0.533
-0.048 -0.645
0.437 0.053
0.128 -0.337
-0.723 0.019
-0.419 0.440
-3.802 -1.367
-0.323 -1.166
2.225 0.417
-5.128 -1.091
-3.297 -1.113
-4.723 -1.407
2.825 -0.004
-0.407 1.190
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FINDINGS
• The purpose of this study is to reduce the risk exposure of the mutual funds
portfolio. Analysis of the above three mutual funds clearly indicates, portfolio
managers can reduce their risk exposure by using hedging instruments.
• At the same time, it is very important to identify the volatile nature of the stocks
that are in the portfolio. If there is continuous fall in single stock and it is of no
use to hedge that, as it is increasing the risk exposure. Therefore it is the foremost
duty of portfolio managers to identify those issues and take decision on either to
sell off or to hedge the same.
• In all the funds discussed above, we are getting the negative returns for the period
between May 2, 2008 and May 24, 2008. Although, it is not possible to have a
perfect hedge, still there is enough chance of reducing the same.
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SUGGESTIONS AND RECOMMENDATIONS
• The above analysis considers the entire portfolio of mutual funds for hedging, but
in some cases we don’t find an underlying index of the portfolio that is trading in
the derivatives market, still hedging can be used as an instrument.
• Consider the stock in the portfolio for which the percentage is high. For example,
lets take an above example of Franklin Infotech Fund. In that funds portfolio
Infosys technology holds more than 30% of the total asset value. Therefore, this
single stock can be hedged, if the underlying stock is trading in the derivatives
market. Here, instead of using index futures, we can apply stock futures as an
instrument for hedging.
• Hedging, it is very nascent in the mutual fund industry. And in the current
scenario, most of the fund managers are hesitant to use derivatives as an
instrument for hedging, because of not clear cut information from the SEBI i.e.
from the regulatory framework. In this study, I have discussed some of the most
important regulations and its implications as well.
• Further, index futures facilitate implementation of portfolio management

strategies and obtained returns. Fund managers can use index futures in their
portfolio strategies, namely, asset allocation, yield enhancement, modification of
portfolio risk, futures as a substitute of indexing and hedging.
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CONCLUSION
1. Hedge Funds are interesting vehicles for investors and academics.

2. Many hedge fund strategies have the ability to generate positive returns in
both rising and falling equity and bond markets. The inclusion of hedge funds
in a balanced portfolio reduces overall portfolio risk and volatility, and
increases returns.
3. A huge variety of hedge fund investment styles – many uncorrelated with each
other – provide investors with a wide choice of hedge fund strategies to meet
their investment objectives.
4. Academic research proves that hedge funds have higher returns and lower
overall risk than traditional investment funds.
5. Hedge funds provide an ideal long-term investment solution, eliminating the
need to correctly time entry and exit from markets.
6. Adding hedge funds to an investment portfolio provides diversification not
otherwise available in traditional investing.
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BIBLIOGRAPHY
Book and Journal Reference
• Dr. Phillip Cottier, “The Origin of Hedge Funds” available at the Hedge Fund
Center, http://www.hedgefund center.com.
• Pandey, I M, Financial Management, Vikas Publishing House Pvt. Ltd.

• Franklin Templeton Investments, Mutual Funds, Facts sheet for the month of
April, May and June.
Web Reference
• www.nseindia.com/org
• www.amfiindia.com/portfolio/franklin
• www.valueresearchonline.com
• www.mutualfundsindia.com/portfolio/pirmafundoffranklin
• www.myiris.com/aspx/derivativeservices
• www.moneycontrol.com/mutualfunds/productsandservices
• www.personalfn.com
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Annexure
1. Franklin Bluechip Fund Portfolio
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2. Franklin Infotech Fund Portfolio
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3. Franklin India Prima Fund Portfolio
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Hedging Techniques IN Mutual Funds (Franklin Templeton)

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HEDGING TECHNIQUES

Submitted to Lovely Professional University

In partial fulfillment of the

OBJECTIVES OF THE STUDY

1. To study, how hedging techniques reduces the risk in investment.

2. To study the application of derivatives in Mutual funds.

3. To comparison of before and after returns of hedging funds.

1. INTRODUCTION TO MUTUAL FUNDS

1.2 Meaning of Mutual Fund

1.3 Organisation Structure of a Mutual Fund

trustee is a company, it is also subject to the provisions of the Indian

O PE N-E N D FUN D/ C LOS E D

Schemes according to maturity period:

Open-ended fund or scheme:

Schemes according to investment objective:

Growth / Equity Oriented Scheme:

Income / Debt Oriented Scheme:

Money Market or Liquid Fund:

Some helpful rules to invest in mutual funds :-

Assess Performance Appropriately: Past performance is no indicator of future results.

2. INTRODUCTION TO DERIVATIVES MARKET

A futures contract is a contract to purchase a specific underlying instrument at a specific

Traders use futures contracts to speculate on the direction of an underlying instrument

Although futures contracts, if held till "delivery", lead to fulfillment of their

Margin and leverage

As long as the position is open this margin is marked-to-market on a daily basis.

2.3.1 PARTICIPANTS IN THE FUTURES MARKET

Hedging involves taking a temporary position in a derivatives contract(s), which is equal

Hedging: Long security, short Nifty futures

Hedging: Short security, long Nifty futures

Speculation in derivatives is a double-edged sword, i.e. there exists a possibility of

Arbitrage is a strategy, which involves simultaneous purchase and sale of identical or

Call Options: Profit and loss

Put Options: Profit and loss

3. HEDGING MUTUAL FUNDS

General Hedging Strategies

· Reducing the equity exposure of a Mutual Fund by selling Index Futures;

3.2. Activities of Fund-Houses

3.2.1. What kind of risk needs to be hedged?

3.3. Risk Management and the Mutual Funds

survey conducted by PricewaterhouseCoopers (PWC) on risk management by mutual

3.4. Hedging minimizes the risk of portfolio

Liquidate a portion of the assets and hold cash

Sell index futures equal to the value of the portfolio

Uses of index futures

Fund managers can use index futures in these ways:

New Schemes: Utilising mainstream governance and disclosure mechanisms

Existing Schemes: Rules governing hedging and portfolio rebalancing.

6.2.1 What does hedging mean?

5. DATA ANALYSIS AND PRESENTATION

5.1. Franklin Bluechip Fund

*Portfolio composition is as of APRIL 30, 2008

Ascertain of Market Lot

Nifty on 2-May 3595

NAV on April 30, 2008:

NAV Total Units (in millions)

Date Total Assets NAV Daily Returns

Returns for the period -14.544

Interpretation for steps 1 and 2:

• Short 32, 936 nifty futures on May 2, 2008

Date Nifty futures Difference Market Profit/Loss

Interpretation for step 3: