Module-3 IFSS-Note

Indian Financial System & Services:Module-III
UNIT-3
MUTUAL FUND
Meaning and Description of a MutualFund
Investors buy equity shares, debentures, jewellery and gold coins, residential and
commercial property with their savings. This is the direct way of investing where assets
bought are held directly in their names.
Direct investments impose on the investors, the following responsibilities of selecting

and managing the investments:
l Selection: Is it the right stock or bond or property tobuy?
l Price: Is it the correct price given for the underlyingstock?
l Timing: Is the time right to buy theinvestment?
l Weighting: How much of each type to buy? How should a portfolio becreated?
l Evaluation: Is there a reason to think that the value of the asset will increase
ordecrease?
l Exit: Is it the right time to sell the investment? Will it be possible to sell iteasily?
l Operations: Are the operational requirements, such as trading and depository
accounts, safe deposit facilities, legal and regulatory compliances inplace?
Not all investors may have the ability to do all that is required to make direct
investments. Some may be unwilling to take on all the activities associated with direct
investing; some may find the cost and time spent on direct investingavoidable.
Investors, who like to invest in the securities markets and other assets but like to engage
someone else to create and manage their portfolio, choose mutual funds. Mutual funds
invest and manage the investors’ money by selecting the investments after evaluating
their prospects, price and performance. Mutual funds take up these tasks for a fee that
the investor pays.
Basic Features of a MutualFund
Srusti Academy of Management 1

l A mutual fund is a pool of investors’ money that is managed by specialistinvestment

managementfirms.
l Mutual funds offer products (also called funds, schemes, plans) to investors, stating
upfront the objectives with which the pooled money will beinvested.
l Investors who invest money in a fund are allotted mutual fund units which represent
their proportional participation in the assets of the mutual fundscheme.
l The money that is mobilised is invested in a portfolio of securities in accordance

with the objectives.
l The portfolio is monitored and managed on behalf of investors by the mutual fund,
without the investors having to directly transact insecurities.
l Details about the securities in which the fund has invested and the performance in
terms of risk and return are periodically disclosed to theinvestors.
l Investors can buy or sell mutual fund units from the fund itself or in the secondary
markets if the schemes arelisted.
l Investors in a mutual fund are unit holders, just as investors in equity are
shareholders. The risk of the portfolio of securities is directly borne by them, without
any assurances or guarantees.
l Mutual funds in India are not permitted to borrow in order to invest in a portfolio.
Unit holders are the sole owners of the assets of the mutualfund.
l The activities of a mutual fund including collecting money from investors, creating
and managing the portfolio are subject to SEBIregulations.
Terms and Concepts Related to MutualFunds
Mutual Fund
The term mutual fund refers to the common pool of funds contributed by investors.
When investors invest in a mutual fund, they give their concurrence to their money being
managed in the way that the investment management company has stated upfront. The
funds and investments of the mutual fund are held in a trust of which the investors alone
are the joint beneficial owners. Trustees oversee the management of the investors’

money by the investment manager. The term “mutual fund” is also used for the fund
house that manages several funds using the same investmentmanager.
Mutual Fund Scheme
A mutual fund may offer multiple products, variously called schemes, plans and funds
to investors. Different schemes launched by a Mutual Fund should ideally be distinct in
terms of asset allocation, investment strategy and other essential aspects. This aspect
helps an investor to evaluate the different types of investment options available in
mutual funds and accordingly take an informed decision to invest in a mutual fund
scheme.
With this underlying objective, SEBI has broadly classified mutual funds into 5
categories:6
l Equity
l Debt
l Hybrid
l SolutionOriented
l Others
Further, SEBI has enlisted the different categories of schemes under the above
mentioned group. Only one scheme per category is permitted, except for:
(a) Index Funds/ ETFs replicating/tracking differentindices
(b) Fund of Funds having different underlyingschemes
(c) Sectoral/ thematic funds investing in different sectors/themes.
The mutual fund houses are expected to put out explicitly the ‘type of scheme’ in their
offer documents/ advertisements/ marketing material for their mutual fundschemes.
Asset Management Company (AMC)

The Asset Management Company (AMC) is the specialist investment manager that
manages the mutual fund. For example, the AMC that manages the Franklin Templeton
Mutual Fund is Franklin Templeton Asset Management (India) Pvt. Ltd. The fund
manager and other persons who conduct the day‐to‐day operations of the mutual fund are
all employees of the AMC. The AMC launches mutual fund schemes, collects money
from investors and manages it. For this the AMC charges a fee from the investors who
invest in the fund. The AMC is the entity with whom the investors of a mutual fund deal
with for all their requirements.
Pooling and Proportionate Representation
Mutual fund pools the money contributed by investors to a scheme and invests them in a
portfolio of securities. The investments made by the fund belong to the investors, who
will share the profits or losses made and the costs incurred in proportion to their
investment.
Example:
l Three investors invest Rs. 10,000, Rs. 20,000 and Rs. 30,000 respectively in a
mutual fund. The pooled sum is Rs. 60,000 and their proportionate holding is in the
ratio1:2:3
l The money is invested in equity shares. After sometime, the shares in which the
funds were invested appreciates in value and are now worth Rs.72,000.
l The value of the investors’ holding in the mutual fund also goes up proportionately
(in the ratio of 1:2:3) to Rs. 12,000, Rs. 24,000 and Rs. 36,000respectively.
Units and Unit Capital
An investor’s investment in a mutual fund is represented by the number of units holding

and a mutual fund investor is called a unit holder. Each unit has a face value, typically
Rs.10. In the above example, if the investors bought the units at the face value, the
number of units that will be allotted to them is 1,000 units (Rs.10,000/Rs.10), 2000 units
(Rs.20,000/Rs.10) and 3000 units (Rs.30,000/Rs.10)respectively.
Mark to Market (MTM)
The money contributed by investors in a mutual fund is invested in a portfolio of

securities. The value of these securities will fluctuate and lead to an increase or decrease
in the value of the portfolio. A mutual fund has to calculate and declare to its investors
the current market value of each unit every day by taking the current market price of the
securities held in the portfolio. This process of valuing the securities at its current market
price is called marking to market (MTM). In the example above, the cost of investment
was Rs. 60,000 and its MTM value was Rs.72,000.
Net Asset Value (NAV)
The NAV is the current value of a mutual fund unit. This will depend upon the current
MTM value of the securities held in the portfolio of the fund and any income earned
such as dividend and interest. From this value, the costs and expenses charged for
managing the fund are deducted. The value remaining is called the net assets of the fund.
Consider the example we used earlier:
l There were 6000 units of Rs.10 eachissued.
l The current market value of the portfolio was Rs.72,000.
l Assume dividend income of Rs.3000 and expenses ofRs.600.
l The net assets are calculated by adding income earned and deducting expenses
incurred from the current market value of the portfolio. The net asset is Rs.74,400.
l The number of units issued were 6000, so the net asset value per unit is 74,400/6000
= Rs.12.40
l The NAV of the fund has moved up from Rs.10 per unit to Rs.12.40 perunit.
The NAV of a fund is calculated every business day so that investors know the value of
their investments. Investors buy and sell units at a price based on NAV.
Pricing of Transactions
It is common for mutual funds to be “open‐ended.” This means there is no fixed maturity
date for the fund, and investors can buy (purchase) or sell (redeem) units on any business
day as per their convenience (business day is the day on which a fund is open for
transactions, and typically excludes holidays). Investor’s transactions are done at a price
linked to the NAV (NAV adjusted for any charges associated with buying or selling).

Transactions are priced using the NAV to ensure parity among investors that buy new
units, investors that stay in the fund, and investors that move out of afund.
Example:
The fund in our earlier example had 6000 units, whose current market value is Rs.
74,400. The face value per unit is Rs.10; the NAV per unit is Rs.12.40.
A.New investor buys 1000 units and pays the face value of Rs. 10 perunit.
l Assets of the fund are now 74400+10000 =84400.
l The NAV will be = 84400/7000 = Rs.12.05.
The NAV has dropped from 12.40 to 12.05, not because the portfolio lost in market
value, but because a new investor came in. Existing unit holders face a loss in NAV due
to the entry of the new investor at face value.
B. New investor buys 1000 units and pays the NAV of Rs.12.40 perunit.
l Assets of the fund are now 74400+12400 =86800.
l The NAV will be = 86800/7000 =Rs.12.40.
The NAV has remained unchanged since the incoming investor paid the NAV not face
value.
C. Existing investor sells 1000 units and receives the face value of Rs.10 perunit.
l Assets of the fund are now 74400 ‐ 10000 =64400.
l The NAV will be = 64400/5000 =Rs.12.88.
The NAV has increased from 12.40 to 12.88, not because the portfolio gained in market
value, but because an existing investor left. Existing unit holders face a gain in NAV due
to the exit of investors at face value.
D. Existing investor sells 1000 units and receives the NAV of Rs.12.40 perunit.
l Assets of the fund are now 74400 ‐ 12400 =62000.
l The NAV will be = 62000/5000 =Rs.12.40

The NAV has remained unchanged since the outgoing investor received the NAV, not
face value.
The NAV remains the same after the fresh purchase of units or redemption of existing
units, if the units are priced at the current NAV.
Fund Running Expenses
Apart from the fees payable to the asset management company, direct expenses incurred
in managing the investment portfolio are charged to investors. The specific types of
expenses that can be charged to the investors and the limits to these expenses are
stipulated by regulation. Expenses are calculated as a percentage of the daily average net
assets managed by the fund. After marking the assets to market for purposes of
computing NAV, funds deduct the expense for each day from the value of the
investments. The NAV is lower to the extent of the expenses. Investors do not pay the
expenses separately; it is already reflected in the NAV. It is common to refer to expenses
in terms of the total expense ratio (TER) as a percentage of net assets.
Loads
Mutual funds may impose a charge on the investors at the time of exiting from a fund
called the exit load. Currently, entry loads are prohibited by SEBI. Mutual funds charge
an exit load linked to the period of holding of the investor. It is calculated as a
percentage of the NAV and reduced from the NAV to arrive at the price that the investor
will get on exiting from the investment.
TYPES
Open‐ended and Closed End Funds
Units of mutual funds are first issued to investors when the scheme is launched.
Subsequently, the investors’ purchase and sale transactions with the fund depend upon
the structure of the mutual fund.
Open‐Ended Funds
l An open‐ended mutual fund does not have a fixed maturitydate.
l Investors can buy additional units from the fund at any time at the current NAV‐

linkedprice.
l Existing investors can sell their units back to the fund at current NAV‐linkedprices.
l An open‐ended fund may also be listed on the stock exchanges fortrading.
Closed‐End Funds
l Aclosed‐endmutualfundissuesunitstotheinvestorsonlywhentheschemeislaunched
i.e. during its new fund offer (NFO) period.
l The fund is closed for subscription and additional units are not issued after the NFO
period by thefund.
l These funds have a fixed maturity date when the fund buys back the units from the
investors at the prevailing NAV‐linked price and the fund iswound‐up.
l The units of closed‐end schemes are mandatorily listed on stock exchanges where
investors can buy and sell among themselves. The mutual fund is not involved in
thesetransactions.
Interval Funds
l Units are allotted to investors when the scheme islaunched.
l The fund specifies transaction periods, such as three days every quarter, when
investors can buy units and sell units directly with thefund.
l The funds are listed on the stock exchanges where the investors can buy and sell the
units amongthemselves.
Relative Performance
A mutual fund invests in a portfolio of securities, whose value changes depending on the
changes in the market. A mutual fund therefore cannot assure or guarantee a rate of
return. The return a fund generates will reflect the return generated by that asset class.
For example, equity funds will generate returns in line with equity markets and with the
volatility that equity investments have. When equity market rise, the equity funds’

performance will also be good and it will decline when equity markets fall. A fund tries
to replicate or better the return of an asset class (usually represented by a marketindex).
Diversification
The value of a portfolio depends upon the price of the securities held in it, which can be
volatile and move up and down over time. However, not all such prices will rise and fall
together or in equal value at any point in time. If prices of banking stocks are moving up,
the prices of technology stocks may be moving down, since these sectors are influenced
by different factors. Even if the banking sector stocks are moving up, every banking
stock may not appreciate to the same extent. Diversification means creating a portfolio
of securities such that the overall portfolio is well balanced across multiple sectors and
securities, so that the rise or fall in prices of the components is smoothened out. Most
mutual fund portfolios are well diversified, unless they are specifically designed to focus
on a single sector. A portion of a well‐diversified portfolio can be bought while investing
in a mutual fund even with a small investment of say, Rs.5000. It may otherwise not be
feasible to replicate a diversified portfolio with such a small amount.
Dividend and Growth Options
Investors are offered two options to receive the returns that the fund has generated ‐
growth and dividend. Dividend plans may offer a further choice of pay‐out or re‐
investment.
l In the growth option, the gains made in the portfolio are not distributed but retained
in the fund. The gains are reflected in the rising NAV. Investors can realise the gains
by selling the units.
l In the dividend pay‐out option, the fund declares dividends from the realised profits
in the mutual fundportfolio.
l In the dividend re‐investment option the dividend declared by the fund is not paid
out, but is re‐invested in the same scheme by buying additional units for theinvestor.
Working of a MutualFund
A mutual fund is managed by the asset management company (AMC). The activities of

the AMC are supervised by its own board of directors and by the board of trustees of the
mutual fund who act in the interest of investors. All major decisions taken by the AMC
are subject to trustee approval. Trustees meet atleast 6 times a year to monitor and
review the activities of thefund.
A mutual fund scheme is first offered to investors in a new fund offer (NFO). This is the
primary market issue for a fund product. The details of the scheme are provided in the
offer document and key information memorandum to enable investors to assess the
scheme before buying the units.
Mutual fund schemes are distributed through a large network of institutional distributors
such as banks and brokers, as well as independent financial advisors. These distributors
are empanelled by mutual funds to sell their schemes. They receive a commission from
the fund called ‘trail’ commission, which is paid periodically as a percentage of net
assets brought in by the distributor for as long as the investor’s money is held in the
fund. Distributors may also be paid a commission by the investors called ‘upfront’
commission depending on the services offered. Investors can also choose to invest
directly in a fund without involving a distributor.
Investors apply for mutual fund units using the prescribed application form and paying
for the units purchased through banking channels. The NFO price is usually the face
value, typically Rs.10 per unit. Ongoing purchases in open‐ended schemes are at NAV‐
linked prices. Mutual funds will define the minimum investment amount for a scheme,
which can vary from Rs.500 for a few schemes, Rs. 5,000 for most schemes, and Rs.
100,000 for a few others. Investors are allotted units at the price applicable on the date of
transaction. The details of the investor’s holding and transactions are maintained under
unique folio numbers created for each investor. Registrar and transfer agents (R&T
agents) facilitate investor services for mostfunds.
The money mobilised from investors is not held by the AMC in its bank account, but by
a specifically appointed custodian. The custodian bank holds the funds as well as
securities on behalf of the investors. The sales teams of the AMC mobilise money
through the distribution channels. The treasury and operations teams work with R&T
agents and custodians to invest and maintain the funds and investor records.

Regulation of MutualFunds
A mutual fund is authorised by regulations to pool funds from investors and invest the
funds on their behalf. The Securities and Exchange Board of India (SEBI) is the primary
regulator of mutual funds in India. Only entities registered with SEBI under the SEBI
(Mutual Fund) Regulations, 1996 can conduct the business of a mutual fund. The
regulatory provisions are designed to protect the interests of the investors who invest in
afund.
Organization structure of Mutual Fund Companies
The functions of Mutual Fund Organizations (MFO) can be described as (a) Collection of
funds from public (b) Investment of funds collected from public in capital market (c) Proper
management of investment portfolio as a trustee to the investor’s money. The investment
made by the public/investors in the AMC under a scheme is divided into number of units.
The investor will be allotted number units in the scheme proportionate to total investment in
the scheme. The investor is thus called unit holders. The Mutual Fund Organizations (MFO)s
with huge resource of investments of public and a team of experts in their employees roll,
analyses investment opportunities in various securities, bonds and financial investments.
Based on the appraisal made by the specialists, investment decisions in the capital market to
buy/sell the securities will be taken. The profit earned in the form of capital appreciation is
distributed among the investors in the scheme after appropriating the administrative and other
overhead expenses.
Who are the parties to mutual funds?
Besides investors the following three parties are involved in Mutual Funds Set up.
1. Trustees
2. Asset Management Company
3. SEBI the regulator.
Trustees: All mutual funds are set up in the form of a trust, which has sponsor,
trustees, asset Management Company (AMC) and custodian. The trust is established by a
sponsor or sponsors like a promoter of a company. The trustees of the mutual fund hold its
property for the benefit of the unit holders. Asset Management Company (AMC) approved by
SEBI manages the funds by making investments in various types of securities. Custodian,

who is registered with SEBI, holds the securities of various schemes of the fund in its
custody. The trustees are vested with the general power of management and supervision over
AMC and they monitor the performance and compliance of SEBI regulations. As per SEBI
regulations at least two thirds of the directors of trustee company or board of trustees must be
independent i.e. they should not be associated with the sponsors. Also, 50% of the directors
of AMC must be independent. All mutual funds are required to be registered with SEBI
before they launch any scheme.
The Asset Management Company (AMC): The Asset Management Company is formed by
the Mutual Fund Organization (MFO) which invests the money for buying of shares,
deposits, bonds, Government securities etc. The AMC makes profit or loss by regular trading
of assets held by it. An AMC should have a minimum of net worth of Rs.10 Crores. The
AMC invest their funds in small cap, mid cap and large cap companies. The companies are
classified as small cap (up to 150Crores), mid cap (between 150 crores to 1500 Crores) , large
cap (above 1500 crores) on the Market capitalization of Companies.
Mutual Fund Investment VS Stock Market Investment
 Shares are a part of a business’s growth strategy, while mutual funds are investment
options for individuals.
 Trading in shares requires you to have a demat account. Mutual funds do not need a
demat account, though if you have one, you can use it to handle mutual funds.
 Mutual funds being a portfolio of stocks of companies pre-determined and altered by
a fund manager, you as an investor have no control over the actual choice or trade of
stocks. You also cannot choose to exit from 1 or 2 of the stocks from the portfolio.
 Mutual funds are managed by a fund manager in an AMC. This external management
of portfolio ensures that there is direct involvement on the part of the investor except at the
time of choosing the fund. For this reason, mutual funds are ideal for a new investor who
does not know much about the stock market. Direct investment in shares, on the other
hand, requires strong knowledge of the stock market and company performances. It is a
hands-on activity involving quick market decisions and is better for experienced stock
traders.
 The passive nature of mutual funds makes it easier for anyone and everyone with
money to take part in it. For direct investment, you need more time and dedication.
 You can invest in mutual funds through a fixed monthly Systematic Investment Plan
(SIP), as it is managed by a professional. You cannot make such a fixed investment in

shares directly as the prices fluctuate constantly and need personal attention and prompt
trade decision.
 Because mutual funds hold a diversified portfolio, negative returns are cushioned by
the other stocks that do well. For example, if your portfolio contains 35 stocks, of which 3
are dropping, even the slightest growth in the other 32 will prevent your overall fund value
from coming down. Direct investment in stocks does not offer you this protection and
makes your stocks volatile. Unless you are dealing in a significant number of stocks at the
same time, your money will be at high risk.
 Mutual funds have a longer-term growth trajectory and will give good returns only
after 5-7 years, while shares could give you quick returns if you buy and sell at the right
time and choose high-growth stocks.
 In mutual funds, you need to pay fund management charges, a front-end load upon
initial purchase, back-end load upon sale, early redemption charges, etc. In direct
investment in shares you need to pay brokerage to the stock broker.
 It is easier to diversify your portfolio using mutual funds – there are options such as
hybrid funds. While dealing with shares, you may not be able to juggle with a large
portfolio yourself.
 Direct investment in shares can give you tax benefits only under Section 80CCG,
while tax benefits on mutual funds can be claimed under Section 80CCG as well as 80C if
it is an Equity-Linked Savings Scheme (ELSS).
Whether you must invest in mutual funds or shares depends on your knowledge and
experience of the market and the amount of time you have. Mutual funds are a great investing
instrument if you are a dilettante and aim for a steady growth of wealth. But if you are a stock
market virtuoso and have enough time in hand, direct investment in shares is a better choice.
What is Venture Capital?
It is a private or institutional investment made into early-stage / start-up companies (new

ventures). As defined, ventures involve risk (having uncertain outcome) in the expectation of
a sizeable gain. Venture Capital is money invested in businesses that are small; or exist only
as an initiative, but have huge potential to grow. The people who invest this money are called
venture capitalists (VCs). The venture capital investment is made when a venture capitalist
buys shares of such a company and becomes a financial partner in the business.

Venture Capital investment is also referred to risk capital or patient risk capital, as it includes
the risk of losing the money if the venture doesn’t succeed and takes medium to long term
period for the investments to fructify.
Venture Capital typically comes from institutional investors and high net worth individuals
and is pooled together by dedicated investment firms.
It is the money provided by an outside investor to finance a new, growing, or troubled

business. The venture capitalist provides the funding knowing that there’s a significant risk
associated with the company’s future profits and cash flow. Capital is invested in exchange
for an equity stake in the business rather than given as a loan.
Venture Capital is the most suitable option for funding a costly capital source for companies
and most for businesses having large up-front capital requirements which have no other
cheap alternatives. Software and other intellectual property are generally the most common
cases whose value is unproven. That is why; Venture capital funding is most widespread in
the fast-growing technology and biotechnology fields.
Need Guidance? Ask from Experts!

Features of Venture Capital investments
 High Risk
 Lack of Liquidity
 Long term horizon
 Equity participation and capital gains
 Venture capital investments are made in innovative projects
 Suppliers of venture capital participate in the management of the company
Methods of Venture capital financing
 Equity
 participating debentures
 conditional loan
THE FUNDING PROCESS: Approaching a Venture Capital for funding as a Company
The venture capital funding process typically involves four phases in the company’s
development:
 Idea generation
 Start-up

 Ramp up
 Exit
Step 1: Idea generation and submission of the Business Plan
The initial step in approaching a Venture Capital is to submit a business plan. The plan
should include the below points:
 There should be an executive summary of the business proposal

 Description of the opportunity and the market potential and size
 Review on the existing and expected competitive scenario
 Detailed financial projections
 Details of the management of the company
There is detailed analysis done of the submitted plan, by the Venture Capital to decide
whether to take up the project or no.
Step 2: Introductory Meeting
Once the preliminary study is done by the VC and they find the project as per their
preferences, there is a one-to-one meeting that is called for discussing the project in detail.
After the meeting the VC finally decides whether or not to move forward to the due diligence
stage of the process.
Step 3: Due Diligence
The due diligence phase varies depending upon the nature of the business proposal. This
process involves solving of queries related to customer references, product and business
strategy evaluations, management interviews, and other such exchanges of information
during this time period.
Step 4: Term Sheets and Funding
If the due diligence phase is satisfactory, the VC offers a term sheet, which is a non-binding
document explaining the basic terms and conditions of the investment agreement. The term

sheet is generally negotiable and must be agreed upon by all parties, after which on
completion of legal documents and legal due diligence, funds are made available.
Types of Venture Capital
The various types of venture capital are classified as per their applications at various stages of
a business. The three principal types of venture capital are early stage financing, expansion
financing and acquisition/buyout financing.
The venture capital funding procedure gets complete in six stages of financing corresponding
to the periods of a company’s development
 Seed money: Low level financing for proving and fructifying a new idea
 Start-up: New firms needing funds for expenses related with marketingand product
development
 First-Round: Manufacturing and early sales funding
 Second-Round: Operational capital given for early stage companies which are selling
products, but not returning a profit
 Third-Round: Also known as Mezzanine financing, this is the money for expanding a
newly beneficial company
 Fourth-Round: Also calledbridge financing, 4th round is proposed for financing the
"going public" process
A) Early Stage Financing:
Early stage financing has three sub divisions seed financing, start up financing and first stage
financing.
 Seed financing is defined as a small amount that an entrepreneur receives for the
purpose of being eligible for a start up loan.
 Start up financing is given to companies for the purpose of finishing the development
of products and services.
 First Stage financing: Companies that have spent all their starting capital and need
finance for beginning business activities at the full-scale are the major beneficiaries of
the First Stage Financing.

B) Expansion Financing:
Expansion financing may be categorized into second-stage financing, bridge financing and
third stage financing or mezzanine financing.
Second-stage financing is provided to companies for the purpose of beginning their

expansion. It is also known as mezzanine financing. It is provided for the purpose of assisting
a particular company to expand in a major way. Bridge financing may be provided as a short
term interest only finance option as well as a form of monetary assistance to companies that
employ the Initial Public Offers as a major business strategy.
C) Acquisition or Buyout Financing:
Acquisition or buyout financing is categorized into acquisition finance and management or

leveraged buyout financing. Acquisition financing assists a company to acquire certain parts
or an entire company. Management or leveraged buyout financing helps a particular
management group to obtain a particular product of another company.
Advantages of Venture Capital
 They bring wealth and expertise to the company

 Large sum of equity finance can be provided
 The business does not stand the obligation to repay the money
 In addition to capital, it provides valuable information, resources, technical assistance
to make a business successful
Disadvantages of Venture Capital
 As the investors become part owners, the autonomy and control of the founder is lost
 It is a lengthy and complex process
 It is an uncertain form of financing
 Benefit from such financing can be realized in long run only
Exit routes
There are various exit options for Venture Capital to cash out their investment:

 IPO
 Promoter buyback
 Mergers and Acquisitions
 Sale to other strategic investor
LEASING
CONCEPT & CLASSIFICATION
Concept
A “lease” is defined as a contract between a lessor and a lessee for the hire of a specific asset
for a specific period on payment of specified rentals. The maximum period of lease according
to law is for 99 years. Previously land or real resate, mines and quarries were taken on lease.
But now a day’s plant and equipment, modem civil aircraft and ships are taken.
Definition:
(i) Lessor:
The party who is the owner of the equipment permitting the use of the same by the other
party on payment of a periodical amount.
(ii) Lessee:
The party who acquires the right to use equipment for which he pays periodically.
Lease Rentals:
This refers to the consideration received by the lessor in respect of a transaction and
includes:
(i) Interest on the lessor’s investment;
(ii) Charges borne by the lessor. Such as repairs, maintenance, insurance, etc;
(iii) Depreciation;

(iv) Servicing charges.
At present there are many leasing companies such as 1st Leasing Company, 20th Century
Leasing Company which are doing quite a lot of business through leasing, It has become an
important financial service and a lucrative avenue of making sizable profits by leasing
companies.
Classification of Leases:
The different types of leases are discussed below:
1. Financial Lease:
This type of lease which is for a long period provides for the use of asset during the primary
lease period which devotes almost the entire life of the asset. The lessor assumes the role of a
financier and hence services of repairs, maintenance etc., are not provided by him. The legal
title is retained by the lessor who has no option to terminate the lease agreement.
The principal and interest of the lessor is recouped by him during the desired playback period
in the form of lease rentals. The finance lease is also called capital lease is a loan in disguise.
The lessor thus is typically a financial institution and does not render specialized service in
connection with the asset.
2. Operating Lease:
It is where the asset is not wholly amortized during the non-cancellable period, if any, of the
lease and where the lessor does not rely for is profit on the rentals in the non- cancellable
period. In this type of lease, the lessor who bears the cost of insurance, machinery,
maintenance, repair costs, etc. is unable to realize the full cost of equipment and other
incidental charges during the initial period of lease.
The lessee uses the asset for a specified time. The lessor bears the risk of obsolescence and
incidental risks. Either party to the lease may termite the lease after giving due notice of the
same since the asset may be leased out to other willing leases.

3. Sale and Lease Back Leasing:
To raise funds a company may-sell an asset which belongs to the lessor with whom the
ownership vests from there on. Subsequently, the lessor leases the same asset to the company
(the lessee) who uses it. The asset thus remains with the lessee with the change in title to the
lessor thus enabling the company to procure the much needed finance.
4. Sales Aid Lease:
Under this arrangement the lessor agrees with the manufacturer to market his product through
his leasing operations, in return for which the manufacturer agrees to pay him a commission.
5. Specialized Service Lease:
In this type of agreement, the lessor provides specialized personal services in addition to
providing its use.
6. Small Ticket and Big Ticket Leases:
The lease of assets in smaller value is generally called as small ticket leases and larger value
assets are called big ticket leases.
7. Cross Border Lease:
Lease across the national frontiers is called cross broker leasing. The recent development in
economic liberalisation, the cross border leasing is gaining greater importance in areas like
aviation, shipping and other costly assets which base likely to become absolute due to
technological changes.
Merits of Leasing:
(i) The most important merit of leasing is flexibility. The leasing company modifies the
arrangements to suit the leases requirements.
(ii) In the leasing deal less documentation is involved, when compared to term loans from
financial institutions.

(iii) It is an alternative source to obtain loan and other facilities from financial institutions.
That is the reason why banking companies and financial institutions are now entering into
leasing business as this method of finance is more acceptable to manufacturing units.
(iv) The full amount (100%) financing for the cost of equipment may be made available by a
leasing company. Whereas banks and other financial institutions may not provide for the
same.
(v) The ‘Sale and Lease Bank’ arrangement enables the lessees to borrow in case of any
financial crisis.
(vi) The lessee can avail tax benefits depending upon his tax status.
Financial Evaluation of leasing
1. Present Value Method:
Under this method the present value of lease rentals are compared with the present value of
the cost of an asset acquired on outright purchase by availing a loan. In leasing, the tax
advantage in payment of lease rentals will reduce the cash outflow.
2. Cost of Capital Method:
Under this method, the rate of cost of capital is calculated for the payments of installments
and then it is compared with the cost of capital of the other available sources of finance such
as fresh issue of equity capital, retained earnings, debentures, term loans etc. The lease option
is chosen if the rate is lower than the cost of equity capital etc. This method does not require
the prior selection of any discounting rate.
3. Bower-Herringer-Williamson Method:
Under this method, the financial and tax aspects of lease financing are considered separately.
The following steps are involved in evaluation of lease decision:
Step

Make a comparison of the present value of cost of debt with the discounted value of gross
amount of lease rentals. The rate of discount applicable is being the gross cost of debt capital.
Then, obtain the total present value of a financial advantage/disadvantage of leasing.
Step 2:
Again compute the comparative tax benefit during the lease period and discount it at an
appropriate cost of capital. The total present value is the operating advantage/ disadvantage of
leasing. Step 3 – When the present value of operating advantage of lease is more than its
financial disadvantage, then select the leasing. When the present value of financial advantage
is more than operating disadvantages, then select the leasing.
HIRE PURCHASE
Conceptual Framework
Meaning: Hire purchase is a method of financing of the fixed asset to be purchased

on future date. Under this method of financing, the purchase price is paid in
installments. Ownership of the asset is transferred after the payment of the last
installment.
Conceptual Framework
Hire Purchase is a kind of instalment purchase where the businessman (hirer) agrees to pay
the cost of the equipment in different instalments over a period of time. This instalment
covers the principal amount and the interest cost towards the purchase of an asset for the
period the asset is utilized. The hirer gets the possession of the asset as soon as the hire
purchase agreement is signed. He becomes the owner of the equipment after the last payment
is made. The hirer has the right to terminate the agreement anytime before taking the title or
the ownership of the asset.
Features of Hire Purchase:
The main features of hire purchase finance are:
1. The hire purchaser becomes the owner of the asset after paying the last instalment.

2. Every instalment is treated as hire charge for using the asset.
3. Hire purchaser can use the asset right after making the agreement with the hire vendor.
4. The hire vendor has the right to repossess the asset in case of difficulties in obtaining the
payment of instalment.
Advantages of Hire Purchase:
Hire purchase as a source of finance has the following advantages:
i. Financing of an asset through hire purchase is very easy.
ii. Hire purchaser becomes the owner of the asset in future.
iii. Hire purchaser gets the benefit of depreciation on asset hired by him/her.
iv. Hire purchasers also enjoy the tax benefit on the interest payable by them.
DISADVANTAGES
Hire purchase financing suffers from following disadvantages:
i. Ownership of asset is transferred only after the payment of the last installment.
ii. The magnitude of funds involved in hire purchase are very small and only small types of
assets like office equipment’s, automobiles, etc., are purchased through it.
iii. The cost of financing through hire purchase is very high.
Financial Evaluation of Hire purchase
Hire purchase is an arrangement for buying expensive consumer goods, where the buyer
makes an initial down payment and pays the balance plus interest in installments. The
term hire purchase is commonly used in the United Kingdom and it's more commonly known
as an installment plan in the United States

Interest on hire purchase: Interest is calculated on Cash value of goods not in instalment

value which includes cash value of goods and interest amount. It is calculated on yearly,
quarterly and yearly basis. Interest is not calculated on down payment which is paid at
delivery of goods
The following points highlight the three methods of accounting for hire-purchase and
instalment payment system.
 Accounting Method 1. Assets Accrual Method:
 Accounting Method 2. Credit Purchase with Interest/Sales Method:
 Accounting Method 3. Interest Suspense Method
LEASING VS HIRE PURCHASE
Points of
Distinction Leasing Hire Purchase
Hirer has the option of purchasing

Lessor is the owner until the the asset at the end of the
Ownership end of the agreement agreement
Duration Done for longer duration Done for a shorter duration
Depreciation Lessor claims the depreciation Hirer claims the depreciation
Payments include the principal

Rental payments are the cost of amount and the effective interest
Payments using the asset for the duration of the agreement
Only interest component is

Lease rentals categorized as categorized as expenditure by the
Tax Impact expenditure by the lessee hirer
The Extent of
Financing Complete financing Partial financing
Repairs and Responsibility of the lessee in Responsibility of the hirer

the financial lease, and of the

Maintenance lessor in operating lease
POSSIBLE /UNIVERSITY QUESTIONS

Possible Questions
(2MARK QUESTIONS)
1. What are the advantages enjoyed by a bank for being a scheduled bank?
2. Can a fixed deposit be claimed before maturity?
3. Distinguish between an overdraft and a cash credit?
4. What does a banker do when the cheque amount stated in words and in figures differs?
5. What are the principles that a banker should adhere to while granting loans and advances?
6. State the circumstances under which the license of an insurance agent may be cancelled?
7. What is the different between medi-claim policy and managed health care policy?
8. What type of services do banks provide as a financial services provider?
9. What do you mean by “Any where banking “mention any two facilities under anywhere
banking?
10. What are the activities termed as cross selling by commercial banks?
11. What is RTGS? Why it is named so?
12. Distinguish between risk & Uncertainty. What are the risk which are covered in life
insurance.
13. Define cheque truncation.
14. What do you mean by “Actuaries Services”
15. Define “ECS”
16. Why is credit card considered to be hybrid product?
17. What is meant by SLR?
18. What is Re-insurance?
19. What is NEFT?
20. Why the payment mechanism of banks is important for the economy?

21. State two objectives of money market.

22. What is Adhoc Treasury bill ?
23. What is Gilt edged security?
24. What is cross border lease?
25. Distinguish between income fund & growth fund?
26. State two features of commercial paper.
27. Name the share indices of BSE & NSE?
28. What do you mean by venture capital?
29. What do you mean by GDR?
30. Mention two features of hire purchase.
31. Name two money market intermediaries.
32. What do you mean by s&p CNX Nifty ?
33. What is margin trading?
34. What are the special features of open-ended fund?
35. What is certificate of deposit?
36. Who are the players in the unorganized sector of the financial system?
37. When do companies use the IPO process?
38. What is the basic nature of capital market?
39. How do stock exchanges facilitate trade?
40. Mention two stock exchanges of India & outside India.
41. What is difference between hive purchase & instalment?
LONG QUESTIONS (16 marks)
1. (a) State & explain banking sector reforms with special reference to prudential norms &
capital adequacy norms.
(b)How does the central bank monitor & supervise the function of its member banks.
2. (a) Discuss the different kinds of proofs of death required for life insurance claim?
(b) Explain the products of Life insurance and General insurance.
3. Discuss how allied services offered by banks add value to the banks as well as to the
customers.
4. Describe KYC .Also discuss the guidelines on KYC issued by RBI?

5. What are the different types of financial markets? Discuss the roles and functions of
financial markets in India.
6. Mutual funds provide stability to share prices, safety to investors and resources to
prospective entrepreneur. Discuss
7. What do you understand by new issue market? Explain the different methods of
marketing corporate securities in the new issue market .Explain the regulations governing
primary capital market in India.
8. (a) Criteria for analysing venture capital proposals.
(b) Difference between Hive purchase & leasing.
9. Explain role & functions of IRDA, RBI, SEBI.
10. (a) Explain online trading system in India.
(b) Types of Booker and their charges.

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Indian Financial System & Services:Module-III

Meaning and Description of a MutualFund

Direct investments impose on the investors, the following responsibilities of selecting

l Selection: Is it the right stock or bond or property tobuy?

l Price: Is it the correct price given for the underlyingstock?

l Timing: Is the time right to buy theinvestment?

Basic Features of a MutualFund

Srusti Academy of Management 1

l A mutual fund is a pool of investors’ money that is managed by specialistinvestment

l The money that is mobilised is invested in a portfolio of securities in accordance

Terms and Concepts Related to MutualFunds

Srusti Academy of Management 2

Mutual Fund Scheme

(a) Index Funds/ ETFs replicating/tracking differentindices

(b) Fund of Funds having different underlyingschemes

(c) Sectoral/ thematic funds investing in different sectors/themes.

Asset Management Company (AMC)

Srusti Academy of Management 3

Pooling and Proportionate Representation

Units and Unit Capital

An investor’s investment in a mutual fund is represented by the number of units holding

Mark to Market (MTM)

The money contributed by investors in a mutual fund is invested in a portfolio of

Srusti Academy of Management 4

Net Asset Value (NAV)

Consider the example we used earlier:

l There were 6000 units of Rs.10 eachissued.

l The current market value of the portfolio was Rs.72,000.

l Assume dividend income of Rs.3000 and expenses ofRs.600.

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l Assets of the fund are now 74400+10000 =84400.

l The NAV will be = 84400/7000 = Rs.12.05.

l Assets of the fund are now 74400+12400 =86800.

l The NAV will be = 86800/7000 =Rs.12.40.

l Assets of the fund are now 74400 ‐ 10000 =64400.

l The NAV will be = 64400/5000 =Rs.12.88.

l Assets of the fund are now 74400 ‐ 12400 =62000.

l The NAV will be = 62000/5000 =Rs.12.40

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Fund Running Expenses

Open‐ended and Closed End Funds

l An open‐ended mutual fund does not have a fixed maturitydate.

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l An open‐ended fund may also be listed on the stock exchanges fortrading.

i.e. during its new fund offer (NFO) period.

l Units are allotted to investors when the scheme islaunched.

Srusti Academy of Management 8

Dividend and Growth Options

Srusti Academy of Management 9

Srusti Academy of Management 10

Organization structure of Mutual Fund Companies

Who are the parties to mutual funds?

Srusti Academy of Management 11

Srusti Academy of Management 12

What is Venture Capital?

It is a private or institutional investment made into early-stage / start-up companies (new

Srusti Academy of Management 13

It is the money provided by an outside investor to finance a new, growing, or troubled

Need Guidance? Ask from Experts!

Srusti Academy of Management 14

Features of Venture Capital investments

Methods of Venture capital financing

THE FUNDING PROCESS: Approaching a Venture Capital for funding as a Company