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j World Com Scam
j LTCM Fiasco
j Mutual Funds
¬ ntroduction
¬ Structure
¬ Advantages
¬ Types
¬ Ratios
¬ NAV
¬ Taxation , Scheme Options
¬ nvestment Strategies
¬ Current Scenario
O
 

About the company
j Started in 1983 by Bill fields under the name
LDDS.
j Bernard Ebbers became CEO in 1985.
j Went public in 1989 and acquired Advantages
company nc.
j Acquired many cos throughout 1990¶s.
j MC acquisition was the biggest worth $40bn.
 List of acquisitions
`
  
   
 

 


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ëenesis of the fraud
j U.S. economy went through the consolidation
phase.
j Share prices had a big role to play.
j Tough competition from mobile telephony and e-
mails.
j Changing business conditions and earning
pressures.
j Resorted to illegal measures.
What was the scam
j Operational day to day expenses termed as
capital expenditure.
j nflated earnings around $4 billion.
j Reserve account was also manipulated.
j EBTDA would have reduced by $6 billion in
2001.
 Line cost expenses(in US$ Bn)
6
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Man behind the scam:
Bernard Ebbers
j Borrowed more than
$1 billion and Pledged
stocks as collateral.
j $400 million loans
authorized .
j Appropriated these
loans for personal
purposes.
j Citibank had
investor¶s interests.
Downfall
j March 2002,SEC sought information about the
fraud.
j April 2002,Ebbers resigned as CEO.
j Planned to cut 17000 jobs . S&P reduced ratings.
j Share prices fell and µsecurities fraud¶ case filed
by SEC in June.
j Filed for bankruptcy ,Ebbers prisoned for 25
years.
Aftermath
j Share and bond holders left with worthless
assets.
j Debt over $30 billion,creditors were unlikely to get
paid.
j 539 Mutual funds owned $400mn in outstanding
shares.

$  %

&

 

2!
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!
 LONë TERM CAPTAL
MANAëEMENT
j1994
jFounded by J.M Meriwether
Scholes
jnitial equity capital of $1.2
billion Merton
11 Partners
jMullins
j 30 Traders
„)+
,-! Meriwether
'


jReturn before fees 28%
jAfter fees 20%
Black

!/%0 %12/*
2 */
„
Scholes +
,
Merton
'
Meriwether

Mullins
TRADNë STRATEëES
j Fixed ncome Arbitrage deals or convergence
trades.
j There were four main types of trade:
j Convergence among U.S., Japan, and
European sovereign bonds;
j Convergence among European sovereign
bonds;
j Convergence between on-the-run and off-the-
run U.S. government bonds;
j Long positions in emerging markets sovereigns,
hedged back to dollars.
TRADNë STRATEëES
j Differences in values were tiny
j Large and highly-leveraged positions
j 1998
j Equity of $5 billion
j Borrowed over $125 billion
j Leverage factor of roughly 30 : 1.
j „+,'.- 

!

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!)*
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 !2
 3,,4 („+,'
j ëenerous financing agreements

j ncreased demand for hedge fund business

j Favourable economic conditions

j A µhalo effect¶ that surrounded LTCM

j Misconceptions about LTCM

j LTCM¶s secrecy
#+„3,,4
j nitial two years till the end of 1997, returns running
close to 40%, the fund has some $7 billion under
management
j From 1998, it achieves only a 27% return ²
comparable with the return on US equities that year.
j Returned about $2.7 billion of the fund's capital back
to investors because "investment opportunities were
not large and attractive enough´
j The portfolio under LTCM's control amounts to well
over $100 billion, while net asset value stands at
some $4 billion; its swaps position is valued at some
$1.25 trillion notional, equal to 5% of the entire global
market.
j LTCM was active in mortgage-backed securities and
was dabbling in emerging markets such as Russia
) 0
)*„+,'5@ )

j Poor risk management

j The $2.7 billion return of capital

j Salomon¶s exit from the market

j LTCM µreduces¶ its risk

j The Russian ruble default

j LTCM¶s desperate attempts to

recapitalize
 &
#(„„
j n May and June 1998 returns from the fund were -
6.42% and -10.14% respectively, reducing LTCM's
capital by $461 million.
j Exit of Salomon Brothers from the arbitrage business
in July 1998.
j By the end of August, the fund had lost $1.85 billion
in capital.
j Liquidate a number of its positions at a highly
unfavorable moment and suffer further losses.
j Experienced a flight-to-liquidity. n the first three
weeks of September, LTCM's equity tumbled from
$2.3 billion to $600 million without shrinking the
portfolio, leading to a significant elevation of the
(32,+ # („ 4
j $1.6 bn in swaps
j $1.3 bn in equity volatility
j $430 mn in Russia and other emerging markets
j $371 mn in directional trades in developed
countries
j $286 mn in equity pairs (such as VW, Shell)
j $215 mn in yield curve arbitrage
j $203 mn in S&P 500 stocks
j $100 mn in junk bond arbitrage
j no substantial losses in merger arbitrage
BaLOUT
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j After the bailout, LTCM continued
operations.
j n the year following the bailout, it
earned 10 percent.
j By early 2000, the fund had been
liquidated, and the consortium of banks
that financed the bailout had been paid
back; but the collapse was devastating
for many involved.
j ëoldman Sachs CEO Jon Corzine
forced out of the office in a boardroom
coup led by Henry Paulson.
j Mullins, once considered a possible successor
to Alan ëreenspan, saw his future with the
Reserve dashed.
j The theories of Merton and Scholes took a
public beating.
j n its annual reports, Merrill Lynch observed that
mathematical risk models "may provide a
greater sense of security than warranted;
therefore, reliance on these models should be
limited.´
CURRENT STATUS
j n 1999, LTCM, Meriwether launched JWM
Partners. Haghani, Hilibrand, Leahy, and
Rosenfeld all signed up as principals of the
new firm.
j By December 1999, JWM raised $250 million
for a fund that would continue many of
LTCM's strategies²this time, using less
leverage.
j Credit Crisis, JWM Partners LLC has been hit
with 44 percent loss since September 2007 to
February 2009 in its Relative Value
Opportunity  fund.
j JWM Hedge Fund shut down in July 2009.
LESSONS LEARNT

j 
   

j  
    


j  
     

j !       

 "#


  

What is a Mutual Fund

A mutual fund is a professionally managed type of

collective investment scheme that pools money from
many investors and invests it in stocks, bonds, short-
term money market instruments and other securities
ADVANTAëES OF MUTUAL FUNDS
j Professional Management
j Diversification
j Convenient Administration
j Return Potential
j Low Costs Liquidity
j Transparency
j Flexibility
j Choice of schemes
j Tax benefits
j Well regulated
Organization of a Mutual Fund
 Regulations
ëoverned by SEB (Mutual Fund) Regulation 1996

All MFs registered with it, constituted as trusts ( under

ndian Trusts Act, 1882)

Bank operated MFs supervised by RB too

AMC registered as Companies registered under Companies

Act, 1956

SEB- Very detailed guidelines for disclosures in offer

document, offer period, investment guidelines etc.
 TYPES OF
MUTUAL FUNDS
 -
7 4
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j available for subscription all through the year
j conveniently buy and sell units at Net Asset
Value ("NAV") related prices
 ,)
7 4
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j pre-specified maturity period.
j transact (buy or sell) the units of the scheme on
the stock exchanges where they are listed
 
0


j nterval Schemes are that scheme, which
combines the features of open-ended and close-
ended schemes. The units may be traded on the
stock exchange or may be open for sale or
redemption during pre-determined intervals at
NAV
 EQUTY FUNDS

ë


 



 




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Equity Funds can be classified
on the basis of market
capitalisation

 


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On the basis of investment strategy the
scheme intends to have







  

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DEBT FUNDS












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Trade in commodities such as steel, sugar, copper etc. or

in shares of commodity companies

Scaled down versions of hedge funds that provide a

chance to retail investors to take a look at commodities
market who otherwise were not able to.

Commodities mutual funds are those investing in certain

designated real assets or their derivatives like futures
contracts

42
TOP FUNDS As on Sep 1,2009
Scheme Name Nature 1M% 6M% 1Y% 3Y%

JM Mid Cap Fund - ërowth Equity 7.19 115.61 38.06 7.90

CC Prudential ncome Debt -1.59 7.95 23.19 -

Reliance RSF - Balanced Balanced 1.18 75.90 30.56 16.36

Reliance MP - ërowth MP 1.07 19.88 26.92 12.53

Escorts Liquid Plan - ër Liquid 0.53 3.98 9.06 8.55

Sahara Taxgain - ërowth ELSS 5.34 88.26 28.35 17.81

Kotak PSU Bank ETF ETF -2.51 79.34 30.91 -

CC Prudential ëFP - ëilt -2.88 3.86 34.53 16.42

HDFC ndex Fund - Sensex ndex 0.07 72.24 13.50 12.80

ETF, Ratios and NAVs
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returns earned in excess of that which could
have been earned on a riskless investment (i.e.
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assumed).

The higher the Trey nor

ratio, the better the
performance under analysis.
 (  

n finance, Jensen's alpha (or Jensen's

Performance ndex, ex-post alpha) is
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UNT 500 EQUTY 680
CAPTAL(5000 SHARES
00000
UNTS@ Rs
10 EACH)
DEBENTURES 170
RESERVES 320 MONEY 80
AND MARKET
SURPLUS NSTRUMENT
S
CURRENT 180 OTHER 70
LABLTES CURRENT
ASSETS
TOTAL 1000 TOTAL 1000



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taxation-need
j Different tax rates for dividend and capital
gains(short/long)

j Knowledge of tax treatment is very important

as ³post tax returns´ is what an investor gets.

j Following parameters decides tax impact:

ncome tax slab
Scheme option (Dividend or ërowth)
Period of holding (upto 1 yr or more)
 Tax slabs
@
 
   



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j #)
Education Cess 3 % chargeable to all
Tax Slabs
j Surcharge 10% levied on tax if income
exceeds Rs.10,00,000
j 41
-!)!!
For Woman ± Rs.1,80,000
For Senior Citizen ± Rs.2,25,000
 Calculation of Post tax Returns
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 taxation
j Two types of taxation
Capital ëains Tax
Dividend Distribution Tax (DDT)

j Taxation arises only when there is a sale of units

j Follow Financial Year (ie April ± March)

j The accepted method is First n First Out (FFO)

Capital ëain Tax
j When you sell units of a mutual fund, you pay tax on the profit
earned from it.

This profit is called Capital ëain

Eg: You bought units at Rs. 10,000 and sold it at Rs. 11,500,
your Profit/Capital ëain is Rs. 1,500.
The tax paid on Capital ëain is called as Capital ëain Tax.

j Tax is paid on the net profit after adjusting for losses

j Depending upon the period of holding at the time of selling,
capital gains are classified:
Short Term (holding period less than equal to 365 days)
Long Term (holding period more than 365 days)

j Tax Treatment of capital gains are different for equity and debt
Capital ëains Tax - Equity
j Short term Capital ëain Tax: 15% for equity
oriented fund
j An equity oriented fund is one which has
investments of atleast 65% in equity or equity
related instruments

j Long term Capital ëain Tax: NL

j Short term Capital ëain Tax: 15% (only on gain)
You bought mutual fund at Rs. 100,000 and sold it within 1
year at Rs. 1,10,000.
Your Capital gain is Rs. 10,000
Sold within 1 year, hence it is short term capital gains
Therefore, Capital ëain Tax = 15% * Rs. 10,000
= Rs. 1,500

j Long term Capital ëain Tax:

f you sold units after 1 year, it will be long term capital gain
and therefore, tax on it will be NL
Capital ëain Tax - Debt
j Short term Capital ëain Tax: Clubbed into
taxable income; and the tax will be as per the
ncome Tax slab of the individual ie. from
10.30% to 33.99%

j All investments which are not classified as

³equity oriented´

j Long term Capital ëain Tax: 10% without

indexation or 20% with indexation whichever
is less
ndexation
j ndexation is an adjustment for nflation

j t is to allow for Cost escalation

j Under ndexation, you are allowed by law to

inflate the cost of your asset by a government
notified inflation factor.

j Value of ³purchase price´ say, 10 yrs back of

Rs.100 is not same today.t is for this reason
adjustment is required.
ndexation
j This factor is called the µCost nflation ndex¶ (C),
from which the word µndexation¶ has been derived.

j C is declared by the ncome Tax department every

year
j nflated Cost =

nflation ndex for year in which asset is sold

-------------------------------------------------------
nflation ndex for year in which asset was bought
This index is then multiplied by the original cost of the
asset to arrive at inflated cost.
Capital ëain Tax - Debt
j )  
 ,-!
! +1 ,
 !)
1
!0)
; i.e. tax slab varies from 10.30%
to 33.99%
1)f you buy a debt fund and sell it within 1 year, the
capital gain will be clubbed to your taxable
income
2)f your income is more than 10 lacs and say, short
term capital gain from debt fund is Rs. 10,000.
Your taxable income will be: 33.99% * Rs. 10,000
=Rs, 3,399
 Capital ëain Tax - Debt
j „)
,-!
!+1 „)
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!)!
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1!)2

1)nvestment made of Rs. 1,00,000 in the year 2000

and sold it @ Rs. 1,50,000 in year 2008.
2)Long term capital gain : Rs. 50,000
3)10% without ndexation: 10% * Rs. 50,000
= Rs. 5,000
 Capital ëain Tax - Debt
j 20% with ndexation:
ndexed Value of Rs. 100,000
582 (C of year 2008)
= Rs. 100,000 * ---------------------------
406 (C of year 2000)
= Rs. 143,350
Capital ëain after ndexation
= Rs. 150,000 ± Rs. 143,350 = 6,650
Tax @ 20% * 6,650 =1,330
j Tax Payable is Rs. 5,000 or Rs. 1,330 whichever
is LOWER.
 Dividend Distribution Tax (DDT)
j Tax paid on Dividend by Fund house is termed as
Dividend Distribution Tax

j Dividend in the hands of investor is # + +1
.

j However, it is borne by investor as AMC deduct

Dividend Distribution Tax (DDT) before paying it
to investor.
DDT - Equity/ Equity Funds
j Dividends are +8(244on Equity/
Equity oriented Funds
1)A fund having more than 75% exposure in equity is defined as
Equity Fund for taxation purpose.

i)You received Rs. 10,000 as dividend from equity funds.

ii)t will be TAX FREE.

j DDT for equity oriented mutual fund is NL
DDT ± Debt Funds
j Debt Fund comprises of following categories:
i)Liquid Funds
ii)FMPs
iii)ncome Funds
iv)MPs
Debt Oriented Balanced Funds
ëilt Funds
j Liquid Funds are treated differently for Dividend
Distribution Tax purpose
j DDT for Corporates (other than liquid) is 20% (plus
Surcharge plus education cess) makes it 22.66%
DDT ± Debt Fund
j DDT on liquid fund is higher than rest of the debt funds.

1)DDT on Liquid Funds: 28.325 % [DDT 25% plus surcharge

(10%) and education cess (3%)]
i)Fund house declared a dividend worth Rs. 10,000 on liquid
fund
ii)mpact of DDT:
= Rs. 10,000 ± (Rs. 10,000/1.28325)
= Rs. 10,000 ± Rs. 2,207 = 7,793
j THS WLL NOT BE DEDUCTED FROM THE DVDEND ±
ADJUSTMENT S N THE NAV
DDT ± Debt Fund
j DDT on debt funds other than liquid funds#:
14.1625% [DDT 12.5% plus surcharge (10%) and
education cess (3%)]
i)Fund house declared a dividend worth Rs. 10,000 on debt
fund other than liquid fund
ii)mpact of DDT:
= Rs. 10,000 ± (Rs. 10,000/1.141625)
= Rs. 10,000 ± Rs. 1241 =8,759
j THS WLL NOT BE DEDUCTED FROM THE DVDEND ±
ADJUSTMENT S N THE NAV
Section 80C
j Deduction of Rs. 1,00,000 is available under this
section for investments made in PPF; nsurance
as well as ELSS schemes
j Effective saving is as under:
i)ndividual in tax bracket 20.6% - the amount of tax
saved is Rs. 20,600
ii)Maximum saving is Rs. 33,990
 Tax structure-summary
a a 
 ( )

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j 2 most common mistakes
Comparing PRE-TAX returns
Example: Debt Fund dividend option attracts 14.1625% DDT
and Bank FD returns are taxable as per individuals
applicable tax slab (i.e. from 10.30% to 33.99%)
WRONë TENURE for rates.
Example: nvestors compare Debt Funds (8.00% p.a.) with 5
years FD (8.50% p.a.), 3 months FD just offer 5.00% p.a.
0

 -!)
j
) -!)
Similar to dividend payout but the amount is re-
invested in the scheme at the prevailing NAV

j &! !
 -!)

Profits are distributed as dividend
NAV reduces when dividend is paid out

j &! !
2
!
 -!)

automatic process
nvestment strategy
j SP
Fixed sum of money periodically

STP
nitial investment - in debt funds then systematically
transferred to equity funds .
j SWP
Withdraw a specified sum of money each month
from his investments in the Scheme
 RUPEE COST
AVERAëNë(strategy)

j On the basis of return

j Benefits
i)When market goes UP buy less units.
ii)When market goes down buy more units.

ëood for an SP in case of an equity MF over a

tenure of 3-5 years
conclusion
j RCA- in terms of amount better than in terms of
RCA ±in terms of quantity

j reference-excel sheet
CURRENT SCENARO

£ No entry load

£ No advisory fees

£ No AMC fees

£ More concentration on ULPS

91