Revision and Practice Test Kit

Version 2

For AMFI Mutual Fund (Advisors) Certification Examination
February 2003

Uma Shashikant Prudential ICICI Asset Management Company Ltd.

Chapters 1 & 2

Introduction & Mutual Fund Products Approximate Weightage: 6 questions, 7 marks

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Key Points • • • • • • • • • • • A mutual fund is a pool of money collected from investors and is invested according to stated investment objectives. Mutual fund investors are like shareholders and they own the fund. Mutual fund investors are not lenders or deposit holders in a mutual fund. Everybody else associated with a mutual fund is a service provider, who earns a fee. The money in the mutual fund belongs to the investors and nobody else. Mutual funds invest in marketable securities according to the investment objective. The value of the investments can go up or down, changing the value of the investors’ holdings. The net asset value (NAV) of a mutual fund fluctuates with market price movements. The market value of the investors’ funds is also called as net assets. Investors hold a proportionate share of the fund in the mutual fund. New investors come in and old investors can exit at prices related to net asset value per unit. Advantages of mutual funds to investors are: o Portfolio diversification o Professional management o Reduction in risk o Reduction in transaction cost o Liquidity o Convenience and flexibility Disadvantages of mutual funds to investors are: o No control over costs o No tailor made portfolios o Problems of managing a large portfolio of funds UTI was the only mutual fund during the period 1963-1988. UTI was the only fund for a long period and enjoyed monopoly status. UTI is governed by the UTI Act, 1963. In 1987 banks, financial institutions and insurance companies in the public sector were permitted to set up mutual funds. SEBI got regulatory powers in 1992. SBI Mutual Fund was the first bank-sponsored mutual fund to be set up. The first mutual fund product was UTI’s Master Share in 1986. The private sector players were allowed to set up mutual funds in 1993. In 1996 the mutual fund regulations were substantially revised and modified. In 1999 dividends from mutual funds were made tax exempt in the hands of investors. Mutual fund assets in mid-2002 were approximately Rs. 1,00,000 crore. Mutual funds can be open ended or closed end. In an open-ended fund, sale and repurchase of units happen on a continuous basis, at NAV related prices, from the fund itself. The corpus of open-ended funds, therefore, changes everyday.

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A closed-end fund offers units for sale only in the IPO. It is then listed in the market. Investors wanting to buy or sell units have to do so in the stock markets. Usually closed-end funds sell at a discount to NAV. The corpus of a closed-end fund remains unchanged. Mutual funds also offer equity linked savings schemes (ELSS) that have the following features: 3 year lock in Minimum investment of 90% in equity markets at all times Open ended or closed end Rebate of 20% under section 88 for investments up to Rs. 10,000. Gilt funds are funds that invest only in government securities Sectoral funds are also called as specialty funds. Equity funds are risky; liquid funds have the lowest risk. Equity funds are for the long term; liquid funds are for the short term. Investors choose funds based on their objective, risk appetite, time horizon and return expectations.

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Chapters 3 & 4

Sponsor, Trustee, AMC and Other Constituents Approximate Weightage: 2 questions; 3marks

Key Points • • • • • • • • • • • • • • • • • • Mutual funds in India have a 3-tier structure of Sponsor-Trustee-AMC. Sponsor is the promoter of the fund. Sponsor creates the AMC and the trustee company and appoints the boards of both these companies, with SEBI approval. The mutual fund is formed as trust in India, and not as a company. In the US mutual funds are formed as investment companies. The AMC’s capital is contributed by the sponsor. Investors’ money is held in the Trust (the mutual fund). The AMC gets a fee for managing the funds, according to the mandate of the investors. The trustees make sure that the funds are managed according to the investors’ mandate. Sponsor should have at least a 5-year track record in the financial services business and should have made profit in at least 3 out of the 5 years. Sponsor should contribute at least 40% of the capital of the AMC. Trustees are appointed by the sponsor with SEBI approval. At least 2/3 of trustees should be independent. At least ½ of the AMC’s Board should be of independent members An AMC cannot engage in any business other than portfolio advisory and management. An AMC of one fund cannot be Trustee of another fund. AMC should have a net worth of at least Rs. 10 crore at all times. AMC should be registered with SEBI. AMC signs an investment management agreement with the trustees. 3

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Trustee company and AMC are usually private limited companies. Trustees are required to meet at least 4 times a year to review the AMC. The investors’ funds and the investments are held by the custodian, who is the guardian of the funds and assets of investors. Sponsor and the custodian cannot be the same entity. R&T agents manage the sale and repurchase of units and keep the unit holder accounts. If the schemes of one fund are taken over by another fund, it is called as scheme take over. This requires SEBI and trustee approval. If two AMCs merge, the stakes of sponsors changes and the schemes of both funds come together. High court, SEBI and Trustee approval needed. If one AMC or sponsor buys out the entire stake of another sponsor in an AMC, there is a take over of AMC. The sponsor who has sold out, exits the AMC. This needs high court approval as well as SEBI and Trustee approval. Investors can choose to exit at NAV if they do not approve of the transfer. They have a right to be informed. No approval is required, in the case of open-ended funds. For closed-end funds, investor approval is required for all cases of merger and takeover (as per the curriculum). Closed end fund investors also do not have exit option.

Chapter 5

Legal and Regulatory Framework Approximate Weightage: 4 questions; 4 marks. Key Points • • • • • • • • • • • • • • • • Mutual funds are regulated by the SEBI (Mutual Fund) Regulations, 1996. SEBI is the regulator of all funds, except offshore funds. Bank-sponsored mutual funds are jointly regulated by SEBI and RBI. If there is a bank-sponsored fund, it cannot provide a guarantee without RBI permission. RBI regulates money and government securities markets, in which mutual funds invest. Listed mutual funds are subject to the listing regulations of stock exchanges. Since the AMC and Trustee Company are companies, any complaints against their board can be made to the CLB. Investors cannot sue the trust, as they are the same as the trust and cannot sue themselves. UTI does not have a separate sponsor and AMC. UTI is governed by the UTI Act, 1963 and is voluntarily under SEBI Regulations. SROs are the second tier in the regulatory structure. SROs get their powers from the apex regulating agency, act on their instructions and regulate their own members in a limited manner. SROs cannot do any legislation on their own. All stock exchanges are SROs. AMFI is an industry association of mutual funds. AMFI is not yet a SEBI registered SRO. AMFI is regulated by its own board made up of its members.
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Chapter 6

Offer Document and Key Information Memorandum Approximate Weightage: 7questions; 12 marks

Key Points • • • • • • • • • • • • • • • Offer Document (OD) is the most important source of information for investors. Abridged version of the OD is called as Key Information Memorandum (KIM). Investors are required to read and understand the offer document. No recourse is available to investors for not reading the OD or KIM, as they sign the form stating that they have read the OD. The cover page contains the details of the scheme being offered and the names of sponsor, trustee and AMC. Mandatory disclaimer clause of SEBI should also be on the cover page of the Offer document. OD is issued by the AMC on behalf of the trustees. KIM has to be compulsorily made available along with the application form. Closed end funds issue an offer document at the time of the IPO. Open ended funds have to update OD at least once in 2 years. Trustees approve the contents of the OD and KIM. The format and content of the OD has to be as per SEBI guidelines. The AMC prepares the OD and is responsible for the information contained in the OD. The Compliance Officer has to sign the due diligence certificate. He is usually an AMC employee. The due diligence certificate states that: o Information in the OD is according to SEBI formats o Information is verified and is a true and fair representation of facts o All constituents of the fund are SEBI registered SEBI does not approve or certify the contents of the OD. Factors common to all funds are called as standard risk factors. These include market risk, no assurances of return, etc. Factors specific to a scheme are scheme-specific risk factors in the Offer Document.These include restrictions on liquidity such as lock-in period, risks of investing in the first scheme of a fund, etc. Fundamental attributes of a scheme include its basic features. For any change in fundamental attributes, investor approval is not needed. Trustees and SEBI should approve the change. Each investor should be informed through a communication and given the option to exit without paying any exit load. A scheme cannot make any guarantee of return, without stating the name of the guarantor, and disclosing the networth of the guarantor. The past performance of the assured return schemes should also be given. Information on existing schemes and financial summary of existing schemes to be given for 3 years. Information on transactions with associate companies to be provided for the past 3 years. If any expense incurred is higher than what was stated in the OD, for past schemes, explanations should be given. 5

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There is no information on other mutual funds, their product or performance in the OD. Investors’ rights are stated in the OD. The borrowing restrictions on the mutual fund should be disclosed. This includes the purposes and the limits on borrowing. Investors have the right to inspect a number of documents. These are: o Trust deed o Investment management agreement o SEBI (MF) Regulations o AMC annual reports o Unabridged offer document o Annual reports of existing schemes 3 years track record of investors’ complaints and redressal should be disclosed in the OD. Any pending cases or penalties against sponsors or AMC should be disclosed in the OD. The offer document contains detailed information, while the KIM is a summary form of the OD. If any information is crucial to the investor, it will be found in both KIM and OD. For example, the details of guarantee if the scheme is an assured return scheme. The name and addresses of trustees and AMC directors will be found in the KIM, but the details of their role, responsibilities and duties will not be found in the KIM, but only in the OD. The OD and KIM are documents of a mutual fund and there will be no information about other mutual funds in an OD. There will be no comparisons are data on performance of other mutual funds. The OD and KIM will not contain names of securities in which the mutual fund plans to invest. Only broad allocation will be given.

Chapter 7

Processes, rights and obligations for investors Approximate Weightage: 4 questions; 5 marks

Key Points • • • • • • Categories of investors eligible to apply is stated in the offer document. Whether a certain class of investor, such as a trust or a company can invest in a fund, depends on the list of eligible investors in the OD. Non-resident Indians (NRIs) and overseas corporate bodies (OCBs) are eligible to invest in mutual funds. Foreign nationals and entities cannot invest in mutual funds. Any investor who becomes a foreign citizen after investing in a fund, has to compulsorily redeem the units after obtaining foreign citizenship. The curriculum does no explicitly recognise a Person of Indian Origin (PIO). Therefore any Indians seeking foreign citizenship should redeem their units. This is not the case in reality, but is the expected answer in the examination. 6

Revision and practice test kit

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FIIs can invest in mutual funds. They invest through the Non-resident rupee account. RBI permission for NRIs, OCBs and FIIs is a blanket permission. Every investment does not need RBI approval. Prospective investors have no legal remedies. Agents can sell products of multiple mutual funds. Agents are appointed after they clear the AMFI exam and sign an agreement with the AMC on non-judicial stamp paper. Fees and commissions are decided by the AMC and not subject to any regulation. Investors have the right to receive redemption proceeds within 10 days. Investors have the right to sue the AMC, Trustees or Sponsor. Investors cannot sue the Trust as they are the Trust and can’t sue themselves. An open ended fund opens for sale and repurchase within 30 days from the date of closure of the IPO. Investors do not have any remedy for performance of the fund being below the investors’ expectations. If investors representing 75% of the unit capital approve, the AMC’s services can be terminated, or the scheme can be wound up. The first right of the investor is towards the trustees. If a fund does not redress their complaint they can go to SEBI. AMFI does not require that every investment decision must be approved by an investor.

Chapter 8

Tax Aspects Approximate weightage 1 question; 2 marks

Key Points • • • • • • • • Mutual funds themselves pay no tax on the incomes they earn. They are fully exempt from tax. If an investor holds units for 12 months or less, any gain from selling the units is called as short-term capital gain. Short-term capital gains are taxable at the marginal rate of taxation of the investor. If an investor’s holding period is more than 12 months, any gain or loss from sale is called as long-term capital gain. Long-term capital gain can be indexed for inflation. Indexing refers to updating of the purchase price, based on the cost of inflation index published by the CBDT.The formula for indexation is purchase price X (index in the year of sale/index in the year of purchase). Investors can pay either 10% tax (plus surcharge) on the capital gain tax without indexation or 20% (plus surcharge) on capital gains after indexation, which ever is lower. Example:

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An investor invests Rs. 4,00,000 in a mutual fund. He sells his investments after 2 years for Rs. 6,00,000. What is the capital gains tax payable, without indexation? (Ignore surcharge). o In the above case the capital gain is Rs. 2,00,000, on which 10% is payable as capital gains tax, without indexation. This amounts to Rs. 20,000.

Chapter 9

NAV and Pricing Approximate Weightage: 2 questions; 3marks.

Key Points • • • • • • • • • • • • • • Load is charged to the investor when the investor buys or redeems (repurchases) units. Load is an adjustment to the NAV, to arrive at the price. Load that is charged on sale of units is called as entry load. An entry load will increase the price, above the NAV, for the investor. Load that is charged when the investor redeems his units is called an exit load. Exit load reduces the redemption proceeds of the investor. Load is primarily used to meet the expenses related to sale and distribution of units. An exit load that varies with the holding period of an investor is called a (contingent deferred sales charge) CDSC. To arrive at the sale price, given NAV and load (%), we have to calculate the amount of load and add it to the NAV. The amount of load will be = NAV x (entry load/100). To arrive at the sale price, given NAV and load (%), we have to calculate the amount of load and reduce it from the NAV. The amount of load will be = NAV x (exit load/100). Load is subject to SEBI regulations SEBI has stipulated that the maximum level of entry or exit load cannot () be higher than 7%. SEBI also stipulates that the repurchase price cannot be less than 93% of the sale price. o Minimum repurchase price, given sale price is = NAV X (1 – 7%) For closed end funds, the maximum entry of exit load cannot be higher than 5%. The repurchase price cannot be less than 95% of the sale price.

Chapter 10

Revision and practice test kit

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Equity Markets and Mutual Funds Approximate Weightage: 2 questions; 3 marks.

Key Points • • The investment pattern of the fund is primarily dictated by the fund objectives. A fund manager whose style is value investing, will prefer to invest in established profit making companies, and will buy only if the price is right. He will look for “undervalued” shares, which have a value proposition that is yet to be recognized by the market. A fund manager, whose style is growth, is more aggressive and is willing to invest in companies with future profit potential. He is willing to buy even if the stock looks expensive. He focuses on sectors that are expected to do well in future, and will be willing to buy them even at higher prices. Equity stocks can be classified as large cap and small cap stocks. Large cap stocks are liquid and trade every day. They are established companies offering normal profit potential. Small cap stocks provide higher return potential. But they are generally not very liquid. Cyclical stocks are those whose performance is closely linked to macro economic factors. P/E ratio is the ratio of earnings per share (EPS) to market price per share. Growth shares sell at higher P/E ratios than value shares. Dividend yield is the ratio between the dividend per share and market price per share. Growth shares have lower dividend yields than value shares. If the market prices move up, P/E ratios are higher and dividend yields are lower. If the market prices move down, P/E ratios are lower and dividend yields are higher. An active fund manager hopes to do better than the market by selecting companies, which he believes, will outperform the market. A passive fund manager simply replicates the index, and hopes to do as well as the index. A passive fund manager tries to keep costs down and has to rebalance his portfolio if the composition of the index changes. Fundamental analysis is the analysis of the profit potential of a company, based on the numbers relating to products, sales, costs, profits etc, and the management of a company. Technical analysis is an analysis of market price and volumes, to identify clues to the market assessment of a stock. A fund manager focuses on asset allocation; a dealer buys and sells shares; and an analyst researches companies and recommends them for buy and sell.

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Chapter 11

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Debt Markets and Mutual Funds Approximate Weightage: 2 questions; 3marks.

Key Points • • • • Debt Instruments are issued by government, banks and companies. They can pay interest on fixed rates, floating rates or on discounted basis. If no interest is paid, such an instrument is a zero coupon instrument. Debt markets are wholesale markets in which large institutional investors operate. Banks are the largest players in debt markets. • About 96% of secondary market trading happens in government securities. • Basic characteristics of bonds are as follows: o Principal value, par value, or face value is the amount representing the principal borrowed and the rate of interest is calculated on this sum. On redemption this amount is payable. o Coupon is the interest paid periodically to the investor. o Maturity date is the date on which a bond is redeemed. Term to maturity or tenor is the period remaining for the bond to mature. o Put option refers to the option to the investor to redeem the bond before maturity. Call option is the option to the borrower to redeem before maturity. o If interest rates go up, above the coupon rate, investors may exercise the put option. If interest rates fall below the coupon rate, issuers may exercise the call option. Current yield is the ratio of coupon amount to market price of a bond. If a bond, paying coupon at 8% is selling in the market for Rs. 105, the current yield is 8/105 = 7.62%. Changes in interest rates impacts bond values, in the opposite direction. An increase in interest rates leads to a fall in bond values; a decrease in interest rates leads to an increase in bond values. Duration of a bond helps measure the interest rate risk of a bond. It is the weighted average maturity of a bond. Credit risk refers to the risk of default. The base rate or benchmark rate in the bond market is the rate at which the government borrows in the market. All other borrowers pay a rate that is higher, due to the presence of credit risk. The difference between the benchmark rate and the rate that is paid by other borrowers is called the credit spread. (Called as yield spread in the AMFI book).

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Chapter 12 Revision and practice test kit 10

Restrictions on Investment Approximate Weightage: 3 questions; 4 marks.

Key Points • • • • • • • Mutual funds can invest only in marketable securities. A mutual fund, under all its schemes, cannot hold more than 10% of the paid-up capital of a company. Except in the case of sectoral funds and index funds, a mutual fund scheme cannot invest more than 10% of its NAV in a single company. Investments in rated investment grade issues of a single issuer cannot exceed 15% of the net assets and can be extended to 20%, with the approval of the trustees. Investment in unrated securities cannot exceed 10% of the net assets for one issue and 25% of net assets for all such issues. Investment in unlisted shares cannot exceed 5% of net assets for an open-ended scheme, and 10% of net assets for a closed end scheme. Inter scheme transfers are allowed by the SEBI regulations, provided: • Such transfers happen on a delivery basis, at market prices. • Such transfers do not result in significantly altering the investment objectives of the schemes involved. • Such transfer is not of illiquid securities, as defined in the valuation norms. A mutual fund can borrow a sum not exceeding 20% of its net assets, for a period not exceeding 6 months. This facility is clearly designed as a stopgap arrangement, and is not a permanent source of funds for the scheme. A fund can borrow only to meet liquidity requirements for paying dividend or meeting redemptions. All investment made in the marketable securities of the sponsor and its associated companies must be disclosed by the mutual fund in its annual report and offer document. A mutual fund scheme cannot invest in unlisted securities of the sponsor or an associate or group company of the sponsor. A mutual fund scheme cannot invest in privately placed securities of the sponsor or its associates. Investment by a scheme in listed securities of the sponsor or associate companies cannot exceed 25% of the net assets of the scheme.

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Chapter 13 & 14

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Accounting and Valuation Approximate Weightage: 4 questions; 6 marks.

Key Points • • • • • • • • • • • • • Investor’s subscriptions to the mutual fund are accounted as unit capital, and not as liabilities or deposits. Assets of a mutual fund are the investments made by the fund. Liabilities of a mutual fund are strictly short term in nature. The unit capital account is maintained at face value. NAV is the net assets per unit, computed as net asset divided by number of units outstanding. The day on which NAV is calculated is called as the valuation date. All mutual funds have to disclose their NAV everyday, by posting it on the AMFI web site by 8.00 p.m. Open-ended funds have to compute and disclose NAVs everyday. Closed end funds can compute NAVs every week, but disclosures have to be made everyday. Initial issue expenses of a scheme cannot exceed 6% of funds mobilised. Any amounts above this have to be borne by sponsors or AMC. For a closed end fund, initial issue expenses are charged over the life of the scheme, on a weekly basis. For an open-ended scheme, the initial issue expenses are carried in the balance sheet of the fund as “deferred revenue expenses”. They are written off over a period not exceeding 5 years. The maximum limit on the expenses that can be charged to an equity mutual fund are: • For net assets up to Rs. 100 crore: 2.5% • For the next Rs. 300 crore of net assets: 2.25% • For the next Rs. 300 crore of net assets: 2% • For the remaining net assets: 1.75% • These limits are lower by 0.25% for debt funds These regulatory ceilings are applied on the weekly average net assets of the mutual fund scheme. The investment management fees are regulated by SEBI as follows: • For the first Rs. 100 crore of net assets: 1.25% • For net assets exceeding Rs. 100 crore: 1.00% Valuation of equity shares is done on the basis of traded price; provided that price is not more than 30 days old. Debt securities with less than 182 days to maturity are valued on accrual basis. The accrual is calculated as follows:

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A t-bill is issued at Rs. 80 and redeemed at Rs. 100 after 364 days. The accrual per day is = 20/364 = 0.5494 • Illiquid securities cannot be more than 15% of the portfolio’s net assets. Any illiquid assets above this limit have to be valued at zero.

Chapter 15 & 16 Revision and practice test kit 12

Risk, Return and Performance Approximate Weightage: 7 questions; 11 marks. Key Points • • • • • • • Rate of return is computed as: (Income earned/Amount invested)*100. This number can be annualised by multiplying the result by the factor 12/n, where n is the number of months in the holding period. If the holding period is in days, the above factor will be 365/n, where n is the number of days in the holding period. Change in NAV method of calculating return is applicable to growth funds and funds with no income distribution. Change in NAV method computes return as follows: (NAV at the end of the holding period – NAV at the beginning of the holding period)/NAV at the beginning of the period. Return is then multiplied by 100 and annualised. The total return with re-investment method or the ROI method is superior to all these methods. It considers dividend and assumes that dividend is re-invested at the ex-dividend NAV. Total Return or ROI Method computes return as follows: • [(Value of holdings at the end of the period - value of holdings at the beginning of the period)/ value of holdings at the beginning of the period] x 100 • Value of holdings at the beginning of the period = number of units at the beginning x begin NAV. • Value of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAV. • Number of units re-invested = dividends/ex dividend NAV. Expense ratio is an indicator of efficiency and very crucial in a bond fund. Income ratio is the ratio of net investment income by net assets. This ratio is important for fund earning regular income, such as bond funds, and not for funds with growth objective, investing for capital appreciation. Portfolio turnover rate refers to the ratio of amount of sales or purchases (which ever is lesser) to the net assets of the fund. Higher the turnover ratio, greater is the amount of churning of assets done by the fund manager. High turnover ratio can also mean higher transaction cost. This ratio is relevant for actively managed equity portfolios. If the turnover of a fund is 200%, on average every investment is held for a period of 6 months. Risk arises when actual returns are different from expected returns. Standard deviation is an important measure of total risk. Beta co-efficient is a measure of market risk. The quality of beta depends on exmarks. If ex-marks are high beta is more reliable. Ex-marks are an indication of extent of correlation with market index. Index funds have ex-marks of 100%. Comparable passive portfolio is used as benchmark. Usually a market index is used as a benchmark. Compare both risk and return, over the same period for the fund and the benchmark. Risk-adjusted return is the return per unit of risk. Comparisons are usually done • With a market index • With funds from the same peer group 13

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With other similar products in which investors invest their funds

When comparing fund performance with peer group funds, size and composition of the portfolios should be comparable. Treynor and Sharpe ratios are used for evaluating performance of funds. The quality of beta depends on ex-marks.

Chapter 17

Financial Planning Process Approximate Weightage: Chapters 17 – 22: 25 questions; 37 marks

Key Points • Financial planning comprises a. Defining a client's profile and goals b. Recommending appropriate asset allocation c. Monitoring financial planning recommendations Financial planning helps a mutual fund distributor to establish long-term relationships and build a profitable business. Financial planning is a very profitable business in the US. Steps in financial planning are: a. Asset Allocation b. Selection of fund c. Studying the features of a scheme Financial planning is concerned only with broad asset allocation, leaving the actual selection of securities and their management to fund managers. Investors delegate the task of investing in securities to the fund manager. The financial planner can only work with defined goals and cannot take up larger objectives that are not well defined. The client is responsible ultimately for realising the goals of the financial plan. The basis of genuine investment advice should be financial planning to suit the investor's situation Risk tolerance of an investor is not dependent on the market, but his own situations.

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Chapter 18 Life Cycle and Wealth Cycle Stages Revision and practice test kit 14

Key Points • The life cycle stages of an investor can be classified as follows: o Childhood stage o Young unmarried stage o Young married with children stage o Married with older children stage o Pre-retirement stage o Retirement stage The income level of investors, the saving potential, the time horizon and the risk appetite of an investor depend on his life cycle. Younger investors have higher income and saving potential, take longer-term view and may be willing to take risks. Older investors may have limited income and saving, shorter time horizon, and unwilling to risk their savings. There are 3 wealth cycle stages for investors: • Accumulation stage is when investors are earning and have limited need for investment income. They focus on saving and accumulating wealth for the long term. Equity investments are preferred in this stage. • Transition stage is when financial goals are approaching. Investors still earn incomes, but have also draw on their earnings. Investors choose balanced portfolios that have both debt and equity. • Reaping stage or distribution stage in when investors need the income from their investment, and cannot save further. They reap the benefits of their savings. They prefer debt investments and preserving of capital at this stage. Inter-generational fund transfer refers to transfer of wealth to an investor. The preferred investment avenue will depend on the life cycle and wealth cycle stage of the beneficiaries. These investors who transfer wealth do not require financial planning. Sudden wealth surge refers to winnings in games and lotteries. Investors should be advised to temporarily park their funds in money market investments and create a long-term plan after thinking through the plan. They must also take into account the impact of tax. Affluent investors are of two types: • Wealth preserving investors who are risk-averse and like to invest in debt. • Wealth creating investors who prefer growth and are willing to take the risk of equity investments.

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Chapter 19

Investment Products Prudential ICICI Mutual Fund 15

Key Points • Key features of all investment options should be remembered. Please note that the questions are based on the date of the curriculum, which is December 2001. Any changes in rates and other features after that date are not included in the examination. For example, rate on the RBI Relief Bond, for the exam, is 8.5% and not 8%. Physical assets like gold and real estate are preferred by investors who like physical ownership. These investments are not liquid. Physical assets are perceived to be a hedge against inflation. Real estate investment requires high initial investments. Bank deposits are preferred by a large number of investors due to the perception of bank deposits being safe and free of default. Features of PPF o 15 years deposit product made available through banks. o 9.5% p.a. interest payable on monthly balances. o Minimum Rs. 100 and maximum Rs. 60,000 p.a. investment allowed. o Tax benefits u/s 88 under IT Act. o Interest receipt and withdrawal of principal exempt from tax. o Limited liquidity available. o Only individuals and HUFs are eligible to invest Features of RBI Relief Bonds o Issued by banks on behalf of the RBI. o Tenure of five years. o 8.5% p.a. interest payable semi-annually. o Option to receive or reinvest interest. o Interest income exempt from tax. Features of other government schemes o Indira Vikas Patra and KVP issued by central government and sold by post offices. o Current yield on IVP is 10.5% (according to the curriculum). o Interest is taxable. o Investor identity is protected and investment in cash is possible. Features of instruments issued by companies o Commercial Paper: Short term (90days) unsecured instrument. Credit rated. o Debentures: Secured fixed income instruments with credit rating. o Equity Shares – Liquidity through listing. o Preference Shares – Fixed rate of dividend. o Fixed Deposits – Unsecured deposits with credit risk. o Bonds of FI – Unsecured fixed income securities issued by public financial institutions. Features of insurance policies Investors buy due to tax concessions, while they should buy for the insurance cover. With profit policy provides bonus along with sum assured. Without profit policy only provides insurance cover. Why MF is the best option o Mutual funds combine the advantages of each of the investment products. o Dispense the shortcomings of the other options. o Returns get adjusted for the market movements.

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Chapter 20

Investment Strategies

Key Points • • • Investors should choose to allow their investment to compound over the long run. This can be achieved by choosing the growth or re-investment option of mutual funds. Automatic reinvestment plans can also be used. Buy and hold strategy which is preferred by many investors, may not be beneficial because investors may not weed out poor performing companies and invest in better performing companies. Rupee-cost averaging (RCA) involves the following: • A fixed amount is invested at regular intervals. • More units are bought when price is low and fewer units are bought when price is high. • Over a period of time, the average purchase price of the investor’s holdings will be lower than if one tries to guess the market highs and lows. RCA does not tell indicate when to sell or switch from one scheme to another. This is a disadvantage. Investors use the systematic investment plan or automatic investment plan to implement RCA. Value averaging involves the following: • A fixed amount is targeted as the desired value of the portfolio at regular intervals. • If markets have moved up, the units are sold and the target value is restored. • If markets move down, additional units are bought at the lower prices. • Over a period of time, the average purchase price of the investors’ holdings will be lower than if one tries to guess the market highs and lows. Value averaging is superior to RCA, because it enables the investor to book profits and rebalance the portfolio. Investors can use the systematic withdrawal and automatic withdrawal plans to implement value investing. Investors can also use a money market fund and an equity fund to implement value averaging.

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Chapter 21

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Asset Allocation and Model Portfolios

Key Points • • • • • Asset allocation is about allocating money between equity, debt and money market segments. Asset allocation varies from one investor to another depending on their situation, financial goals and risk appetite. A model portfolio creates an ideal approach for the investors’ situation and is a sensible way to invest. The asset allocation for an investor will depend on his life cycle and wealth cycle. Investors can have two strategies: • Fixed asset allocation • Flexible asset allocation Fixed asset allocation means • Maintaining the same ratio between various components of the portfolio • Re-balancing the portfolio in a disciplined manner Fixed allocation means a periodical review and returning to the original allocation. If equity is going up, such investors would book profits. They are disciplined. Flexible allocation means allowing the portfolios profits to run, without booking them. If equity market appreciates, flexible asset allocation will result in higher percentage in equity than in debt. Graham recommends that most investors should choose a 50:50 allocation, that is 50% in equity and 50% in debt. Bogle recommends that age, risk profile and preferences have to be combined in asset allocation • Older investors in distribution phase - 50% equity; 50% debt • Younger investors in distribution phase - 60% equity; 40% debt • Older investors in accumulation phase - 70% equity; 30% debt • Younger investors in accumulation phase - 80% equity; 20% debt Steps in developing a model portfolio for the investors: • Develop long term goals • Determine asset allocation • Determine sector distribution • Select specific fund schemes for investment Jacob’s Model Portfolios • Accumulation phase o Diversified equity: 65 - 80% o Income and gilt funds: 15 - 30% o Liquid funds: 5% • Distribution phase o Diversified equity: 15 - 30% o Income and gilt funds: 65 - 80% o Liquid funds: 5%

• • • • •

Chapter 22 Fund selection Revision and practice test kit 18

• •

Fund selection refers to the actual choice of funds according to the chosen model portfolio for the investor. Equity funds: Characteristics: o Fund category – the fund chosen should be suitable to investor objective o Investment style – Choose between growth and value depending on investor’s risk perception o Age of the fund – Experienced funds are preferred to new funds o Fund management experience –Track record of the fund managers is important o Size of the fund – Larger funds have lower costs o Performance and risk – risk adjusted performance matters

• •

High beta means higher risk. High turnover means high transaction costs.

o Equity Funds: Selection Criteria o Percentage holding in cash should be low – Funds can always sell liquid stocks for liquidity requirements. o Concentration in portfolio should be low – An equity fund should be well diversified. o Market capitalization of the fund – High capitalization means better liquidity o Portfolio turnover – Higher turnover means more transactions and costs, but exploitation of opportunities. Low turnover represents patience and stable investments. Risk Statistics o Beta – represents market risk, higher the beta higher the risk. o Ex-Marks – represents correlation with markets – higher the ex-marks, lower the risk. A fund with higher ex-marks is better diversified than a fund with lower ex-marks. o Gross dividend yield represents return. Funds with higher gross dividend yield should be preferred. o Funds with low beta, high ex-marks and high gross dividend yield are preferable Debt Funds: Selection Criteria o A smaller or new debt fund may not necessarily be risky.

o o o o

Total return rather than yield to maturity (YTM) is important. Expenses are very important, because high expense ratios lead to yield sacrifice. Credit quality - Better the rating of the holdings, safer the fund. Average maturity - Higher average maturity means higher duration and interest rate risk. Funds with higher average maturity are more risky than funds with lower average maturity. Money Market Funds o Liquidity and high turnover rate is high. o Shorter-term instruments are turned over more frequently. o Protection of principal invested is important. o NAV fluctuation limited due to low duration and lack of interest rate risk. o Credit quality of portfolio should be high. o Low expense ratio is important.

• • • ratio.

For debt funds expense is important. For short-term investors, load is more important than expense ratio. For long-term investors, expense ratio is more important than expense

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Sample Test - 1

1.

A mutual fund is not a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. A portfolio of stocks, bonds and other securities A company that manages investment portfolios A pool of funds used to purchase securities on behalf of investors A collective investment vehicle

(1 mark)

2. After UTI, the first mutual funds were started by Private sector banks Public sector banks Financial institutions Non-banking Finance Companies

(1 mark)

3. Mutual fund can benefit from economics of scale because of Portfolio diversification Risk reduction Large volume of trades None of the above

(1 mark)

4. Equity Linked Savings Scheme does not have which of the following features? It entitles the unit holder to tax rebate The investment is locked in for 3 years

(2 marks)

A minimum stated level of investments is made in equity and equity related instruments None of the above (1 mark) NAV Fund Size Rate of Return Number of Distributors (1 mark) Balanced Funds Gilt Funds Equity Growth Funds Debt Funds (2 marks) Is appointed for safekeeping of securities Need not be an entity independent of the sponsors Not required to be registered with SEBI Does not give or receive deliveries of physical securities (1 mark) A Trust A Private limited company An asset management company A trustee company (1 mark)

5. A close ended mutual fund has a fixed

6. Of the following fund types, the highest risk is associated with

7. The custodian of a mutual fund:

8. The Mutual fund is constituted as

9. A Self Regulatory Organisation can regulate

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a. b. c. d. a. b. c. d. 11.

All entities in the market Only its own members in a limited way Its own members with total jurisdiction No entity at all (1 mark) SEBI RBI Jointly by SEBI & RBI AMFI (1 mark)

10. Bank owned Mutual Funds are supervised by

In case of merger of two AMC, 75% of the unit holders have to approve the merger in case of a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. Open ended funds Both open and close ended funds Close ended funds None of the above (1 mark) Board of Trustees Company Law Board SEBI RBI (2 marks) Signed by a Compliance Officer of the mutual fund A certificate that all legal formalities of a scheme are completed Attached to Annual report A part of offer document (1 mark) 1 fiscal year 2 fiscal year 3 fiscal year Six months (2 marks) 50% of the unit holders 50% of the trustees 75% of the unit holders None of the above (1 mark) a. b. c. d. Details of the Sponsor and the AMC Description of the Scheme & investment objective/strategy Investors' Rights and Services Performance of other mutual funds (2 marks)

12. The first level regulator of AMCs is

13. As per SEBI guidelines, a due diligence certificate is not

14. An offer document contains an AMCs investor grievances history for the past

15. For scheme to be able to change its fundamental attributes, the fund managers must obtain the consent of a. b. c. d.

16. SEBI does not require the following to be included in the offer document issued by a mutual fund

17. Mutual funds do not justify the need for paying commission to agents when the investors skip out of the scheme before a specified period. In India this practice is adopted by a. b. c. Agents voluntarily paying back the commission to the Mutual fund Trail commission is not paid to the agents None of the above

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d. a. b. c. d. a. b. c. d.

The whole of commission is paid to the agents (1 mark) The AMC The trustees The sponsor if returns have been guaranteed by them None of the above (1 mark) Can distribute several mutual funds simultaneously Cannot appoint sub-agents or sub-brokers Should be only individuals not companies or banks Should not be an employee or associate of the AMC (2 marks)

18. An aggrieved unit-holder of a mutual fund can sue

19. Distributors or agents

20. If a charitable trust approaches a distributor with an application for investment in a mutual fund, the distributor should a. b. c. d. Accept the application without wasting time Reject the application outright Refer to the offer document Accept the application as a direct application (2 marks)

21. One of your friends who have invested in a mutual fund is about to get Canadian citizenship. What would you advise? a. b. c. d. a. b. c. d. a. b. c. d. He should transfer the investment to his relative He should get RBI approval for continuing If he does not need the money, he can continue He should immediately redeem his investment since foreign citizens are not eligible investors (1 mark) Adequate disclosures should be made to the investors Funds should be managed in accordance with stated investment objectives Conflict of interest should be avoided in dealings with directors or employees Each investment decision should be approved by investors (2 marks) Obtaining from the trustees any information having an adverse effect on their investments Inspecting major documents of a fund Receiving of a copy of the annual financial statements of that fund Approving investment decisions of the fund (2 marks) a. b. c. d. a. b. c. d. 10% 12% 20% None (1 mark) Is higher for investors who stay invested in the scheme longer Is lower for investors who stay invested in the scheme longer Is the same for all investors irrespective of how long they stay invested Is not allowed to be charged to mutual fund investors in India

22. The AMFI code of ethics does not cover the following prescriptions

23. Unit holders' right to information does not include

24. A Debt fund distributes 10% dividend. How much tax does the investor have to pay on this dividend?

25. Contingent Deferred Sales Charge (CDSC)

26. The amount required to buy 100 units of a scheme having an entry load of 1.5% and NAV of Rs.20 is: (2 marks)

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a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. (2 marks) a.

Rs.2000 Rs.2015 Rs.1985 Rs.2030 Value fund Growth fund Balanced fund Equity diversified fund (1 mark) Economy stocks Cyclical Stocks Value Stocks Growth stocks (2 marks) Stocks that are currently undervalued in the market Stocks whose worth will be recognized by the market in the long term High current yield Long term capital appreciation (1 mark) Reinvestment risk Default risk Inflation risk Interest-rate risk (2 marks) Also rise Fall Are not affected Fluctuate either up or down (2 marks) Total net assets 50% of net assets 25% of net assets 20% of net assets (2 marks) >25% of its net assets >10% of its net assets Not at all >5% of net assets (1 mark) In the form of long-term loans Strictly short term in nature Combination of long term and short term Not allowed as per regulations

27. A high P/E multiple of a fund in comparison to average market multiple could be of (1 mark)

28. A company whose earnings are strongly related to the state of economy is a

29. A value manager does not look for

30. A bond's rating indicates its

31. When interest rates rise, bond prices

32. As per SEBI, mutual funds can borrow for short term to the extent of

33. A mutual fund is not allowed to invest in the sponsor company,

34. Liabilities in the balance sheet of a mutual fund are

35. A funds weekly average net assets are Rs. 1000 crore. What is the limit on the expenses of the fund? Rs. 10.5 crore

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b. c. d.

Rs. 10.25 crore Rs. 20.5 crore Rs. 17.5 crore (2 marks)

36. A fund's investments at market value total Rs.700 crores, Total liabilities stand at Rs.50 lacs and the number of units outstanding is 28 Crores. What is the NAV? a. b. c. d. a. b. c. d. Rs.30.19 Rs.24.98 Rs.32.15 Rs.40.49 (1 mark) The security is valued at the last quoted price The security is valued on the basis of earnings capitalisation Marking to market is applied If the security has not been traded on valuation date, the trading price on any previous date may be used, provided that date is not more than 30 days prior to valuation date. 38. A high portfolio turnover in an equity fund means a. b. c. d. a. b. c. d. The fund is very active in market Transaction costs are high The fund may be quite risky All of the above (1 mark) Be able to beat the benchmarks Earn the same returns as the benchmark Have no benchmarks Under-perform when compared with the benchmark (2 marks) (1 mark)

37. For valuation of traded securities, which of the following is not true?

39. An actively managed equity fund expects to

40. An Investor buys one unit of a fund at an NAV of Rs.20. He receives a dividend of Rs.3 when the NAV is Rs. 21. The unit is redeemed at an NAV of Rs.22. Total Return is a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. 25.71% Rs. 27.51 21.27% Rs. 21.75% (1 mark) BSE Sensex S&P CNX Nifty BSE 200 S&P CNX Sectoral Indices The fund manager The investment objective of the fund SEBI AMFI Total expenses and average net assets Total expenses and total assets Average expenses and average net assets None of the above (1 mark)

41. For evaluating sectoral funds, the preferred benchmark would be the

42. The appropriate benchmark for evaluating a fund's performance depends on (1 mark)

43. The Expense Ratio as a measure of a fund's performance is defined as (2 marks)

44. The most suitable measure of fund performance for all fund types is

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a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. (2 marks) a.

NAV Change Total Return Total Return with reinvestment None of the above (1 mark) Allocating funds to asset classes (e.g. debt, equity etc.) Allocating funds to individual securities Tracking stocks which they feel have potential None of the above (1 mark) Defining a client's profile and goals Recommending appropriate asset allocation Monitoring financial planning recommendations All of the above (1 mark) Asset Allocation Selection of fund Studying the features of a scheme None of the above The financial planner The investor himself A professional fund manager An objective advisor (1 mark) Less potential for capital appreciation High purchase price Depreciation in value as time passes Value gets eroded due to inflation (1 mark) 10.5% 11% 10% 9% (2 marks) 5 years 6 years 7 years 8 years Yield Rate of interest Credit rating of the deposit None of the above

45. Financial planners and their clients should focus on

46. Financial Planning comprises

47. Which of the following is the first step in financial planning

48. Within an asset class, which individual security to invest in should be decided by (2 marks)?

49. The biggest disadvantage of investment in real estate is

50. The current yield on Indira Vikas Patra works out to

51. The maturity period of RBI Relief Bonds is

52. The most important factor look for when investing in a corporate fixed deposit is the (1 mark)

53. The most important reason for an investor to prefer a bank deposit to a mutual fund is The creditworthiness of the bank

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b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d.

Because the bank does not invest in securities That the bank offers a guarantee All of the above (2 marks) Rs.10000 Between 100 and Rs.60000 Between Rs.600 and Rs.1000 None of the above (1 mark) Balanced fund Growth fund Value fund Income fund (1 mark) Guaranteed returns Long term capital appreciation Low risk High liquidity (2 marks) 9.5% 9.5% before tax 8.5% before tax 8.5% after tax (2 marks) Continuously changing the ratio of various assets in the portfolio Not doing any re-balancing and letting the profits run Active switching None of the above (1 mark)

54. Annual contribution to Public Provident Fund should be

55. Compounding of interest is best explained by a

56. Listing of shares at a stock exchange ensures

57 The annual yield on RBI Relief Bonds is

58. Flexible asset allocation means

59. A very high proportion of investment in all types of equity funds is advisable for investors a. b. c. d. a. b. c. d. In distribution phase In accumulation phase In transition phase Who are wealth preserving affluent individuals (2 marks) Financial planning is required The right investment strategy depends upon who the beneficiaries are The right investment strategy depends upon the state of the stock market All the funds can be invested in aggressive equity funds

60. For older investors who want to transfer their wealth

61. Of the following, which would be suitable for a retiree with a modest risk appetite (1 mark) a. b. c. d. Value Fund Diversified Equity Fund Growth Fund Balanced Fund

62. The strategy advisable for an investor to maximise investment return in the long run is

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(2 marks) a. b. c. d. a. b. c. d. market a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. Fixed Rates of Asset Allocation Flexible Ratio of Asset Allocation Investment without any asset allocation plan Buy and Hold Strategy (2 marks) Investment is for the same amount at regular intervals Over a period of time, the average purchase price will work out lower than if one tries to guess the market highs and lows It does not tell you when to buy, sell or switch from one scheme to another Rupee cost averaging has no serious shortcomings (2 marks) Equity securities Debt funds and fixed income securities Money market Real estate (1 mark) Gives higher returns Is less risky Gives lower returns Is more risky (2 marks) Lower rated portfolio and higher expense ratio Higher rated portfolio and lower expense ratio Lower rated portfolio and lower expense ratio None of the above (2 marks) Gross dividend yield 15% Beta 1.5, Ex-Marks 90 Gross dividend yield 10%, Beta 1, Ex-Marks 70 Gross dividend yield 11%, Beta 0.9, Ex-Marks 80 Gross dividend yield 12%, Beta 1.2, Ex-Marks 80 Buy and hold on to investments for a long time Liquidate poorly performing investments from time to time Liquidate good performing investments fro time to time Switch from poor performers to good performers (1 mark) Financial goals have been already met The investor has retired Financial goals are approaching Investor suddenly gets a windfall (2 marks)

63. The transition phase of an investor's wealth cycle is when the

64. Which of the following lets an investor book profits in a rising market and increase holdings in a falling

65. A criticism of rupee-cost averaging is

66. A wealth preserving affluent investor is likely to invest pre-dominantly in

67. A fund with stable positive earnings

68. Investors should be advised to avoid investing in a debt fund with a

69. Which of the following funds should a risk-averse investor choose?

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Sample Test 2 1. The Board of Trustees of the UTI does not have nominees from a. b. c. d. a. b. c. d. a. b. c. d. RBI LIC IDBI The Bombay Stock Exchange (BSE) (1 mark) In very high quality equity only In instruments issued by companies with a sound track record In short-term securities In government securities only 1992 1993 1998 1995 (2 marks) a. b. c. d. because of a. b. c. d. a. b. c. d. a. b. c. d. Growth in net asset value Reinvestment of dividend Interest received on the fund's assets None of the above (1 mark) Issuing and redeeming units of the mutual fund Updating investor records Preparing transfer documents Investing the funds in securities markets (1 mark)? The AMC The Trustees The Registrars The custodians (2 marks) a. b. c. d. There is a change in the AMC of the schemes that are taken over There is a change in the Sponsor of the schemes that are taken over The scheme has to be wound up compulsorily The schemes’ offer documents have to be changed and updated. a. The apex regulatory authority The markets are bearish Investors perceive that the fund will be unable to maintain the NAV The assets of the fund are undervalued None of the above (2 marks) (1 mark)

2. A gilt fund is a special type of fund that invests

3. The private sector was granted permission to enter the mutual fund industry in (1 mark)

4. A close-ended scheme is quoted on the stock exchange at a discount to its NAV when

5. In the re-investment option offered by mutual funds, the number of units held by an investor increases

6. Transfer Agents of a mutual fund are not responsible for

7. Who is the primary guardian of unit holders' funds/assets

8. If the schemes of a mutual fund are taken over by another mutual fund, which of the following is false?

9. The amount of authority enjoyed by a self-regulatory organisation is defined by (1 mark)

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b. c. d. a. b. c. d. a. b. c. d. a. b. c. d.

Company law board Its own members RBI (1 mark) Promote the interests of the unit holders Set a Code of Ethics Regulate mutual funds Increase public awareness of mutual funds in the country (2 marks) The draft offer document forwarded to SEBI is in accordance with SEBI regulations All legal requirements connected with launching of the scheme have been complied with Disclosures made in the offer document are true, fair and adequate The AMC guarantees a good performance (1 mark) Investment rebate Offer document Key information memorandum None of the above (2 marks)

10. The role of AMFI in the mutual funds industry is not to

11. A due diligence certificate does not certify that

12. Along with the application, it is mandatory to distribute

13. An offer document contains the summary of expenses history of all schemes for the past a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. 1 fiscal year 2 fiscal year 3 fiscal year Six months (1 mark) AMC Unit holders SEBI AMFI (1 mark) Required by investors Required by the AMC for its own reference Required as per SEBI regulations Not mandatory as per SEBI (2 marks) Be described in the offer document Include how redemption or repurchase price of units would be determined Include names of centers where redemption can be effected Indicate the redemption or repurchase price as at the end of the current fiscal year (2 marks) Agents can sell products of a single mutual fund Agents can sell products of mutual funds with whom he has entered into agreements Agents could be only individuals None of the above (1 mark) Through salaries Through commissions

14. Excess distribution expenses are to be borne by the

15. Offer Document of a mutual fund is

16. Procedure for redemption or repurchase need not

17. SEBI guidelines for agents includes

18. Agents are compensated by mutual funds

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c. d. a. b. c. d.

Through an annual fee Not in cash but in kind (1 mark) Requires SEBI’s approval Is a lengthy and cumbersome process Is mandatorily preceded by an AMFI test Does not require any approval

19. An agent's appointment by a fund

20. An investor buys units in a fund that has given excellent returns in the past, but his expectations are not met, as the fund does not perform well this year. The investor can (2 marks) a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. Sue the AMC Sue the Trustees Sue the agent None of the above (1 mark)? No Yes If Ministry of Finance approves If AMFI approves (1 mark) Memorandum and Articles of Association of AMC Consent of auditors and legal advisors Investment management reports Reports based on which actual investments are made Equity funds Debt funds Both the above None of the above (2 marks) Taxable at 20% Not taxable in the hands of unit holders Information is inadequate to assess tax liability Income tax will be assessed as per unit holder’s liability (2 marks) NAV 95% of NAV 93% of NAV 97% of NAV (1 mark) Entry fee Cost of the paper on which the unit certificates are printed The fee the agent charges to the investor The expenses incurred by fund managers for marketing a mutual fund scheme (2 marks)

21. Are Overseas Corporate Bodies allowed to invest in Mutual Funds

22. Documents available to investors for inspection do not include

23. Distribution tax should be taken into account when computing net returns from (2 marks)

24. A mutual fund declares Re 1 as distribution. The income in the hands of unit holders is

25. For a close-ended fund, the repurchase price should not be lower than

26. The "load" charged to an investor in a mutual fund is

27. A passive fund has the following feature a. b. A passive fund tracks the index A passive fund matches the performance of the index

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c. d.

A passive fund selects the stocks that are present in the index All of the above (1 mark) a. b. c. d. a. b. c. d. High current income Undervalued stocks Above average earnings growth None of the above (2 marks) Voting rights Fixed dividend income from post-tax profits Voting rights and unlimited dividend income No guaranteed rights (1 mark) a. b. c. d. a. b. c. d. a. b. c. d. Continuous tracking systems Equity analysts Trustees Security dealers (1 mark) Dividend per share Dividend per face value Dividend per share to current market price None of the above (1 mark) The debt market is a wholesale market There are large players like banks, financial institutions, mutual funds, etc Government securities are traded on a large scale All of the above (2 marks) a. b. c. d. a. b. c. d. a. b. c. d. a. b. Above par Below par At par At a price unrelated to the prevailing interest rate (1 mark) Regional Rural Banks Corporates Scheduled commercial banks None of the above (1 mark) Its current market price Its face value Its fair value The current price of T-Bills (1 mark) Not at all At current market rates

28. A growth manager looks for

29. An owner of preference shares is given which of the following rights

30. Continuous tracking of the companies in which a mutual fund has invested is done by

31. Dividend yield for a stock is

32. Which of the following is applicable to the debt market in India?

33. A bond with a coupon of 9% when interest rates for similar maturities are 11% will sell

34. Certificates of Deposits (CDs) are issued by

35. Current yield relates interest on a security to

36. A mutual fund may transfer investments from one scheme to another

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c. d. a. b. c. d.

At cost price At a fixed premium over market rate (2 marks)

37. Mutual funds are allowed to borrow Freely to meet their requirements For investment purposes only Only to meet redemption demands Not allowed at all

38. Which of the following measures are not taken by SEBI for protecting investors of mutual funds (2 marks) a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. Mandating minimum levels of diversification for mutual funds Ensuring that the funds are not used to favour a few companies Tracking the securities that each fund has Invested in Ensuring that the funds are invested in approved securities only (1 mark) Liabilities Deposits Unit capital None of the above (2 marks) Purchase and sale of investment securities Valuation of all investment securities held Units sold or redeemed All of the above (1 mark) Audit fees Costs related to investor communication Winding costs for terminating the scheme Penalties and fines for infraction of laws

39. In a mutual fund investors' subscriptions are accounted for as

40. A funds NAV is affected by

41. Which of the following expenses cannot be charged to the scheme

42. The valuation norm for non-investment grade, performing assets is done: (2 marks) a. On YTM basis using the Crisil valuation methodology b. On YTM basis with 25% discount c. At 25% discount to face value d. At face value 43. Valuation norms for non-traded securities should be disclosed a. b. c. d. a. b. c. d. At the end of every financial year Every quarter In the offer document at the time of launch of the scheme Should not be disclosed, being confidential information (1 mark) Security is never traded on stock exchange Security is not traded for 30 days Security is not traded for 60 days None of the above (1 mark) a. b. c. Growth fund Index fund Value fund (1 mark)

44. As per SEBI guidelines, a security is to be treated as untraded when

45. Ex-marks with 100 % could be for the following fund:

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d. a. b. c. d.

Balanced fund (1 mark) High transaction costs Greater efficiency High returns to the investor A rising market (2 marks)

46. A high turnover rate for a fund indicates

47. An investor can assess the performance of his mutual fund by comparing it with the performance of

a. b. c. d.

Other mutual fund of the same type The stock market Other financial products All of the above (2 marks)

48. If the NAV of an open-ended fund was Rs.16 at the beginning of the year and Rs.22 after 13 months, the annualized change in NAV is a. b. c. d. 6.0% 34.6% 40.6% 37.5% (1 mark) a. b. c. d. The fund manager The investment objective of the fund SEBI AMFI (2 mark) a. b. c. d. a. b. c. d. Two debt funds with 5 year maturities A broad-based equity fund with an IT Sector Fund A bond fund with a bond index A government securities fund with a government security (2 marks) ROI is a measure similar to Total Return with Reinvestment of distribution Total Return with Reinvestment of distributions assumes reinvestment at NAV on the distribution date As a measure of performance, Total Return with Reinvestment of distribution seeks to overcome the shortcomings of simple Total Return Because of its simplicity, simple Total Return is preferred in practice to Total Return with Reinvestment of distribution 52. Financial planning allows a person a. b. c. d. a. b. To become a billionaire To achieve financial goals through proper management of finances To invest in foreign countries None of the above (1 mark) Defining a client's profile and goals Recommending appropriate asset allocation (1 mark)

49. The choice of an appropriate benchmark for evaluating a fund's performance depends on

50. When comparing a fund's performance with that of its peer group, the following cannot be compared

51. Which of the following is false?

53. Financial Planning comprises

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c. d. a. b. c. d. a. b. c. d. investor a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d.

Monitoring financial planning recommendations All of the above (2 marks) Enabling investors to define financial goals Assessing the investors risk and return requirements Recommending an appropriate asset allocation Selecting securities that will be included in the investor’s portfolio (1 mark) Buying one share each of all listed companies Investing in a mutual fund Borrowing enough money to buy shares of well-managed companies None of the above (2 marks)

54. Financial planning does not include:

55. A small investor can build a diversified portfolio by

56. Direct investment in stock market can be a better option than investing through mutual funds if the

Wants better returns than those offered by mutual funds Has large capital, knowledge and resources for research Has identified a bullish phase in the stock market Wants to invest for the long term (1 mark) Rural investors Investors in high tax bracket Urban investors Investors who want to protect their identity (1 mark) Risk protection Tax benefits Easy liquidity High returns (2 marks) Investments have to be made form taxable income of the relevant year. Investments once made cannot be withdrawn until maturity. Both interest and principal are tax free in the year of withdrawal. Investments enjoy tax benefits under Section 88 of the IT Act. (2 marks)

57. Indira Vikas Patra is an investment product popular with

58. Most individuals invest in life insurance policies for

59. Which of the following about PPF is false?

60. The difference between debenture and bond is: a. b. c. d. a. b. c. d. a. Bonds are issued by corporations and debentures are issued by PSUs. Bonds are unsecured and debentures are secured. Bonds are backed by loans and debentures are backed by assets None of the above.

61. A criticism of rupee-cost averaging is Investment is for the same amount at regular intervals

(2 marks)

Over a period of time, the average purchase price will work out lower than if one tries to guess the market highs and lows It does not tell you when to buy, sell or switch from one scheme to another Rupee cost averaging has no serious shortcomings (1 mark) Accumulating investors

62. A high proportion of investment in income funds is required by

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b. c. d. a. b. c. d. a. b. c. d.

Affluent investors Investors in the inter-generational transfer phase Investors in the distribution phase (1 mark) In distribution phase In accumulation phase In transition phase Who are wealth preserving affluent individuals (2 marks) Maintain balance in their portfolio by liquidating a part of the position in the asset class which has given higher return and reinvesting in the other asset class which has lower return Are not disciplined Increase their equity position when equity prices tend to climb None of the above (1 mark) a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. a. b. c. d. Low post tax returns Dramatic results Better returns than every other available option Only realistic wealth accumulation (2 marks) An aggressive equity fund and a money market mutual fund A value fund and a government securities fund A bond fund and a debt fund A diversified equity fund and a debt fund (2 marks) Standard Deviation measures total risk, not just market risk It is based on past returns, which does not necessarily indicate further performance It is an independent number All types of funds can be measured with standard deviation (1 mark) Investing in a money market mutual fund Investing in an index fund Short term investment in an equity fund Long term investment in an equity fund Current income Total return Liquidity All of the above

63. A high proportion of investment in equity funds is advisable for investors

64. Investors who follow the fixed Asset Allocation approach

65. Mutual fund investors should be advised to expect

66. Which of the following fund types are comparable

67. Which of the following is a disadvantage of standard deviation

68. Which of the following is most risky?

69. Yield-to-maturity of a debt fund is more important if the investment objective is (2 marks)

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Sample Test 3 1. A systematic withdrawal plan is ideal for investors who a. Seek growth as the main objective b. Wish to benefit from market fluctuations c. Prefer a regular income stream d. Not sure about themselves 2. Gilt funds invest in a. IT sector b. AAA securities c. Money market securities d. Government bonds 3. Which of the following is recommended by Bogle for older investors in accumulation stage? a. 50% in equity and 50% in debt b. 60% in equity and 40% in debt c. 70% equity and 30% debt d. 40% equity and 60% debt 4. Illiquid securities in a portfolio a. Cannot be transferred across schemes b. Cannot be more than 15% of net assets c. Cannot be more than 20% of net assets d. a and b are true e. a and c are true 5. Which of the following cannot invest in mutual funds? a. NRIs b. Charitable trusts c. FIIs d. Foreign investors 6. Which of the following is true for assured return schemes? a. Name and net worth of guarantor to be given b. Performance of past assured return schemes to be given c. Whether assurance in earlier scheme was met to be stated d. All of the above 7. Your friend in Dubai wants to invest in a mutual fund. She should be advised to read a. Trust deed b. SEBI regulations c. Offer document d. AMC balance sheet e. All of the above 8. While deciding on asset allocation, an investor must consider a. The stage of his life b. The purpose of making investment c. His risk appetite d. All of the above 9. Mutual funds should be recommended as a. Investments to achieve long term goals b. A get-rich quick option c. Investments to take advantage of stock market d. All of the above 10. A fund manager who believes in the growth philosophy looks for companies with a. Above average earnings growth Prudential ICICI Mutual Fund 37

b. Large equity base c. Likely to go for public issue d. All of the above 11. An open ended fund can change its fundamental attributes by a. Allowing investors to exit after 6 months b. Allowing investors to exit at NAV without a load c. With consent of 75% of investors d. None of the above 12. Which of the following is not a SRO? a. BSE b. NSE c. AMFI d. None of the above 13. Which of the following do not provide a guarantee on capital? a. PPF b. NSC c. Post office deposits d. Units of mutual funds 14. Which are the benchmarks used to evaluate fund performance a. Return on benchmarks like S&P and Sensex b. Return on other funds c. Return on comparable instruments d. All of the above 15. Mutual funds can borrow: a. upto 25% of net assets b. upto 20% of net assets c. For period not exceeding 6 months d. Both a and c e. Both b and c 16. The second mutual fund to be set up in India after UTI was a. Canbank Mutual Fund b. Kothari Pioneer Mutual Fund c. Morgan Stanley Mutual Fund d. SBI Mutual Fund 17. The following is the fund you would advice to an investor who wants to invest for one year a. A debt fund with expense ratio of 1.15% and a entry load of 2% b. A debt fund with expense ratio of 1.2 % and a entry load of 2.5 % c. A debt fund with expense ratio of 1.5% and an entry load of 4% d. A debt fund with expense ratio of 0.5 % and entry load of 3% 18. Mutual funds are described as _____ in the SEBI Regulations, 1996 a. Companies b. AMCs c. Trusts d. Agencies 19. What proportion of a mutual funds trustees have to be independent from the sponsor? a. 50% b. 2/3rd of trustees c. 3/4th of the trustees d. 60% of the trustees 20. Which of the following cannot be distributors of a mutual fund a. Sponsor b. Associate of sponsor Revision and practice test kit 38

c. Associate of AMC d. Employees of AMC 21. Stock exchanges can act as regulators of: a. SEBI registered mutual funds b. Closed end funds listed on the exchange c. All sectoral funds d. All equity mutual funds 22. A mutual fund cannot invest more than _____% of its net assets in un-rated debt of one issuer. Total investments in un-rated debt cannot exceed ____% of net assets. a. 10; 20 b. 15; 25 c. 10; 25 d. 15;20 23. Which of the following is an ideal allocation for a wealth preserving affluent investor? a. 50% equity;50% debt b. 70% equity; 30% debt c. 30% equity;70% debt d. 100% equity 24. If a 8% bond with face value of Rs. 1,000 is selling for Rs. 1,100, what is the current yield? a. 8% b. 7.27% c. 7.8% d. 8.2% 25. If you maintain a flexible asset allocation you would a. Rebalance debt and equity periodically b. Rebalance debt and equity frequently c. Generally avoid portfolio re-balancing d. Keep fixed percentage in debt and equity at all times. 26. Which of the following will NOT require financial planning? a. A 40 years old doctor with substantial savings b. A retiree who is currently getting an income of 4,000 but would want Rs. 10,000 a month c. An old person wanting to transfer all his wealth to his grandchildren d. A young professional aged 26 years 27. What is the portfolio you will recommend to a young couple with two incomes and two children? a. 10% money market; 30% aggressive equity; 25% diversified equity; 35% bond funds b. 40% aggressive equity; 30% money market; 30% bond fund c. 60% equity; 30% money market; 10% debt d. 70% bond funds; 30% equity funds 28. Financial planning is: a. Investing funds to achieve a highest possible rate of return b. Resorting to tax planning to keep taxes as low as possible c. Planning for retirement with maximum income possible d. Process of solving financial problems and reaching financial goals 29. You have just won a huge sum in a lottery. What should your ideal allocation be? a. Invest everything in sectoral funds, as NAV is very low. b. Invest in government bonds, as risk is low. Prudential ICICI Mutual Fund 39

c. Invest in money market funds and decide over the next few months d. Consider the impact of tax e. Both c and d 30. Which of the following is true for closed end funds? a. The fund offers to buy and sell units at NAV b. The corpus of the fund is constant c. The net assets of fund does not change d. None of the above 31. Which of the following represents the transition phase? a. Investor has no need for investment income b. Investor has a long term horizon c. Investor cannot take risks d. Investor’s financial goals are approaching. 32. P/E of which of these stocks is usually high? a. Value stocks b. Cyclical stocks c. Small cap stocks d. Growth stocks 33. If an AMC does not resolve an investor’s complaint, investor can appeal to: a. SEBI b. Ministry of Finance c. Office of the public trustee d. Company Law Board 34. Mutual funds can lend funds in the form of a. Loans b. Promissory notes c. Securities d. None of the above 35. An offer document of an open ended fund has to be revised a. Once in 3 years b. Not at all c. Every year d. Once in two years 36. A FII can invest in a mutual fund through its a. Non resident external account b. Non resident ordinary account c. Non resident rupee account d. RBI current account 37. You invest Rs. 25,000 in a mutual fund. After 2 years you redeem your units at Rs. 32,000. Ignoring indexation and surcharge, what is the capital gain tax on this transaction? a. Rs. 7,000 b. Rs. 700 c. Rs.1,400 d. Depends on the marginal rate of taxation 38. If a fund’s NAV is Rs. 12, what is the maximum sale price it can charge, according to SEBI regulations? a. Rs. 12.70 b. Rs. 12.84 c. Rs. 13.68 d. Rs. 11.16 39. Debt securities with less than 182 days to maturity are valued at a. Face value Revision and practice test kit 40

b. YTM basis c. Accrual basis d. Duration basis 40. If a scheme holds more than 15% in illiquid securities, all securities above that limit have to a. Be valued at book value b. Be valued at a discount of 25% c. Valued at cost price d. Assigned a value of zero 41. Ex-Marks of an equity fund measures its a. Performance b. Risk c. Both the above d. None of the above 42. Which of the following is untrue of an automatic reinvestment plan? a. The plan allows for automatic reinvestment of all income and capital gains b. Automatic reinvestment allows for accumulation of additional units of the fund c. The major benefit of automatic reinvestment is compounding d. The benefit of automatic reinvestment is often lost on account of the heavy load charge on the reinvestment 43. Retired investors should a. Not draw down on their capital b. Not invest in securities which bear risk of capital erosion c. Continue holding a major portion of their holding in equity growth funds d. Never invest in equity 44. A criticism of rupee-cost averaging is a. Investment is for the same amount at regular intervals b. Over a period of time, the average purchase price will work out lower than if one tries to guess the market highs and lows c. It does not tell you when to buy, sell or switch from one scheme to another d. Rupee cost averaging has no serious shortcomings 45. A 55 year old investor, who is employed and earning well, can be said to be in a. Accumulation stage b. Transition stage c. Distribution stage d. Inter-generational wealth transfer stage 46. In order to decide an appropriate index as benchmark for an actively traded fund, one should consider a. Fund size and portfolio composition b. Whether the fund is broad based or focused on specific type of securities c. Investment objective of the fund d. All of the above e. None of the above 47. An equity investor wants to maximise his return in the long run. He should a. Buy and hold investments for a long time Prudential ICICI Mutual Fund 41

b. Invest in gold and silver only c. Keep selling good performing funds d. Keep selling off poor performing schemes and replace them with good performing schemes. 48. Which is the most important factor one should consider before investing in company fixed deposit? a. Interest rate on the deposit b. Assets against which deposits are secured c. Its credit rating d. All of the above e. Only a and c are true 49. After developing a financial plan for a client, financial planners should a. Leave it as it is b. Review it periodically c. Review it once in five years d. None of the above 50. The KIM of a mutual fund scheme is available a. At the AMC office b. At the offices of authorised agents c. At the branches of all banks d. Only a and b 51. Investors can inspect the following documents a. Trust deed b. Agreements with various constituents c. Memorandum and articles of association of AMC and Trustee company d. All of the above 52. A bond has been issued with a call provision. This means the issuer may call it back whenever the interest a. Fall b. Rise c. Change d. Are lower than the coupon rate 53. In determining the holding cost of an investment a. Average cost method is to be followed b. The weighted average cost method is to be followed c. The market value method to be followed d. Either a or b 54. As per wealth cycle guide, during the accumulation stage a. The client looks to build wealth b. The clients’ goals are approaching c. Client cashes out d. Client feels the need to take care of the next generation 55. If the commission paid to agents exceeds the distribution expense rates specified in the offer document, the excess has to be borne by a. AMC b. Trustees c. Unit holders Revision and practice test kit 42

d. DRF of the mutual fund e. Investor protection fund 56. Unit holders who do not agree with the merger of a fund’s scheme have the option to a. Exit from the scheme if it is an open ended scheme b. Exit from the scheme after 6 months c. Cannot exit if the AMC does not permit such withdrawal d. Can exit only after approval of SEBI 57. While choosing between a bank deposit and a debt income fund, the investor must consider a. Credit rating of the bank b. Quality of the mutual fund assets c. His investment objective and risk appetite d. All of the above 58. The jurisdiction for resolving legal disputes concerning a mutual fund is a. Given in the offer document b. Stated in the stock exchanges c. Decided by company law board d. Decided by BSE 59. Passive fund is expected to a. Beat the return of the index b. Furnish the returns of the market index c. Keep the costs low d. Both c and d 60. Which classification of mutual fund does not exist? a. Closed end or open end b. Load fund or no load fund c. Pension fund or insurance fund d. Active fund or passive fund 61. An investor cannot plead ignorance of the procedures while investing in a mutual fund because a. Mutual fund is a risky investment b. Law does not permit the investor to sue the Trust c. While applying the investors sign an agreement stating they have read and understood the terms and conditions d. An investor is expected to be careful while investing 62. A portfolio turnover of 200% implies that an average security stays in a portfolio for a. 6 months b. 12 months c. 48 months d. 36 months 63. Sharpe and Treynor ratios are measures of a. Risk b. Return c. Risk adjusted return d. Beta of the portfolio 64. Company Law Board can hear complaints against a. Agents Prudential ICICI Mutual Fund 43

b. The board of trustees c. Distributors d. Stock exchanges where close ended funds are listed 65. Closed end funds have to calculate and publish their NAV a. Daily b. Monthly c. Quarterly d. Half yearly e. Can compute NAV every week, but disclosures have to be made every day 66. If you bought a fund at Rs. 14 and sold after 2 years at Rs. 22, what is the annualised rate of return, using the change in NAV method? a. 57.14% b. 28.57% c. 36.36% d. 18.18%

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Answers to Sample Tests Sample Test – 1 1. 2. 3. 4. 5. 6. 7. 8. 9. b. b c d b c. a a b 44. c 45. a 46. d 47. a 48. c 49. b 50. a 51. a 52. c 53. a 54. b 55. b 56. d 57. d 58. b 59. b 60. b 61. d 62. d 63. c 64. a 65. c 66. b 67. b 68. a 69. c

10. c 11. c 12. a 13. c 14. c 15. d 16. d 17. b 18. b 19. a 20. c 21. d 22. d 23. d 24. d 25. b 26. d 27. b 28. b 29. c 30. b 31. b 32. d 33. a 34. b 35. c 36. b 37. b 38. d 39. a 40. a 41. d 42. b 43. a

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Sample test 2 1. 2. 3. 4. 5. 6. 7. 8. 9. d d b b b d d c a 36. b 37. c 38. c 39. c 40. d 41. d 42. c 43. c 44. b 45. b 46. a 47. d 48. b 49. b 50. b 51. d 52. b 53. d 54. d 55. b 56. b 57. d 58. b 59. b 60. b 61. c 62. d 63. b 64. a 65. d 66. c 67. b 68. c 69. b

10. c 11. d 12. c 13. c 14. a 15. c 16. d 17. b 18. b 19. c 20. d 21. b 22. d 23. b 24. b 25. b 26. d 27. d 28. c 29. b 30. b 31. c 32. d 33. b 34. c 35. a 70.

Sample Test 3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. c d c d d d c d a a b c d d e d a c b d b c c b c c a d e b d d a c d c b b c d b d b c b d d e b d d d 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. d a a a d a d c c a c b e a

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