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Mutual Funds & Shares in Detail

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Mutual Funds & Shares


Mutual Fund – Concept, Structure and Types

Mutual Fund is an investment plan wherein MF pools investors money to invest in pre-determined goals for capital appreciation.

Benefits of Mutual Funds

  • It’s safe
  • No need to stay updated with market movements
  • Experts manages the investments
  • Tax saving under section 80(c)
  • Investors can invest in any investment option (For example it’s not possible to invest 1 lac in a real estate project, mutual funds makes it possible)

Structure of a Mutual Fund

  • Sponsor (Promoter)
  • Trustees
  • Asset Management Company
  • Custodian
  • R & T Agent
  • Distributors

Sponsor

Sponsor is the promoter of mutual fund and get MF registered with SEBI. Sponsor forms a trust and appoints board of trustees.

Pre-requisites of a sponsor

  • Minimum 40% shareholding in AMC (Asset Management Company)
  • Must have positive net worth in last 5 years
  • Should be in financial services sector during past years from the date of registration

Trust

Trust is the owner of mutual fund. It protects the investors money. Trust acts as a watchdog and keeps an eye on investors money. There should be at least 4 trustees and 2/3 of the trustees should be independent.
Trust signs trust deed with Sponsor

Asset Management Company

ASM pools and invests investor money in pre-stated objective for capital appreciation.
  • In India AMC should be a private limited company
  • Net worth should be at least 10 cr at all times
  • At least 50% directors should be independent

Custodian

  • Custodian is appointed by Trust and it has the custody of assets of Mutual Fund.
  • Sponsor and custodian can never be same
  • Custodian should be registered with SEBI

Registrar and Transfer agents (RTA)

Maintains investors records and handles investors documents. It’s not compulsory to appoint an RTA.

Broad Categories of Mutual Funds

Open Ended Funds

These funds have no fixed corpus  and period . Such fund continuously offer units for sale and is ready to buy  back the units surrendered.

In other words,investors are free to buy from, or sell to , the trust any number if units at any point of time at prices which are liked to the net asset value (NAV) of the units .

Close Ended Funds

In case of these funds, subscriptions from the investors are collected  during a specified  time period and have a fixed corpus. Not a cannot redeem their units till the specified  maturity date. However , to provide liquidity  these are listed on the stock exchange and the investors can purchase and sell through the brokers at the market price without any difficulty .

It may be noted that Unit Trust of India was the first mutual fund started in India as early as 1964.
Later, LIC , GIC  and some nationalised banks also launched their mutual funds with high degree of success. However , during post liberalisation era, many private sector mutual funds have entered the fray. To mention a few . these are: Birla Sun life , HDFC, HSBC,ICICI prudential ,DSP Merrill Lynch , DBS chola mutual Fund.

Major Types of Funds

1. Equity Funds : Equity Funds are considered to be the more risky funds as compared to other fund types , but they also provide higher  returns than other funds. It is advisable that an investor  looking to invest in an  equity fund should  invest for long term i.e. for 3 years or more . There are different types of Equity funds each falling into different  risk bracket.

2. Debt/Income Funds : Funds that invest in medium to long -term debt instruments issued by private companies, banks , financial institution, government and other entities belonging to various sector ( like infrastructure companies etc.) are known as Debt /Income Funds. Debt funds are low risk profile funds that seek to generate fixed current  income (and not capital  appreciation ) to investors. In order to ensure regular income to investors , Debt (or income ) funds distribute large fraction of their surplus to investors. Although debt securities   are generally less risky than equites , they are subject to credit risk (risk to default)  by the issuer at the time or interest or principal payment. To minimize the risk of default , debt funds usually invest in securities from issuers who are rated by credit rating agencies and are considered to be  of “Investment Grade “. Debt funds that target high return  are more risky.
3. Gilt Funds : Also known as Government Securities in India , Gilt Funds invest in government  papers (named dated securities)  having  medium to long term maturity period . issued by the Government of India , these investments have little credit risk (risk of  default) and provide  safety of principal to  the investors . However , like all debt funds , gilt funds too are exposed to interest rate risk.  Interest rates and prices of debt securities are inversely related  and any change in the interest rates results in a change in the NAV of debt/ gilt  funds in an opposite  direction.
 
4. Money Market/Liquid Funds :  Money market /liquid  funds invest in short -term (maturing  within one year) interest bearing debt instrument . These securities are highly liquid and provide safety of investment, thus making investment option when compared with other mutual /liquid funds are exposed to the interest rate risk. The typical investment  option for liquid funds include Treasury Bills (issued by government ), commercial papers (issued by companies ) and certificates of deposit (issued by banks).
 
5. Hybrid Funds:  As the name  suggests , hybrid funds are those funds whose portfolio includes   a blend pf equities , debts and money market securities . Hybrid funds have an equal proportion  of debt  and equity in their portfolio.
6. Commodity Funds : Those funds that focus on investing in different commodities (like metals , food grains . crude oil etc.) or commodity  companies or commodity futures commodity  are termed as commodity  funds . A commodity fund that invests in a single commodity or a group  of commodities  is a  specialized commodity fund and a commodity fund that invests in all available commodities is a diversified commodity  fund and bears less risk than a specialized commodity fund . ” Precious Metals Fund ” and Gold Funds ( that invest in gold, gold futures or shares of gold  mines ) are common example of commodity funds.
 
7. Real Estate Funds : Funds that invest directly in real estate or lend to real estate developers or invest in shares /securitized assets of housing finance companies , are known as specialized Real Estate funds. The objective of these funds may be generate regular income income or investors or capital appreciation.

8. Exchange Traded Funds (ETF) : Exchange traded funds provided investors with combined benefits of a closed -end  and an open -end mutual fund. Exchange traded funds follow stock market indices and are traded on stock exchange like  a single stock at index linked prices. The biggest advantage offered by these funds is that they offer diversification , flexibility of holding a single share (tradable at index linked prices )  at the same time . Recently introduced in India , these funds are quite popular abroad.

9. Fund of funds :  Mutual funds that do not invest in financial  or physical , but do invest in other mutual fund schemes offered by different AMCs, are known as fund of  funds . Fund of Funds maintain  a portfolio  comprising of units of other mutual fund  scheme, just like conventional mutual funds maintain a portfolio comprising of equity /debt money market instrument or non financial assets . Fund of Funds provide investor with an added advantage of diversifying into different mutual fund schemes with  even a small amount   of investment , which further  helps in diversifying of risks . However , the expenses of fund of funds are quite high on account of compounding expenses of  investments into different mutual fund schemes.

mutual funds

Shares:

When companies look for money for their business, they can get it in two ways – either they borrow from a bank and pay interest (“debt”) or they ask people like you and me to invest and give us shares (“equity”). A share is a part of a business.

Then let’s say a friend named Sarath wants to buy a share of this business but the company has got all the money it needs. So Sarath asks us to sell our shares to him, at a higher value than we bought it. So he will own our share of the company, but he’s willing to pay more because he thinks the company will do well. Now we make a profit and then Sarath perhaps sells it to someone else at even higher values etc. The company doesn’t really get affected because it isn’t seeing the money, but the share price goes up as the company starts doing better, and as more people begin to want the shares.

Why does the share price go up? The answer is: Perceived value. I may think the company is worth 1 crore, but someone else might think it’s worth 2 crores. When my shares reach my valuation I sell, but someone else will think it’s a good deal and buy.

To organise such buying and selling, there are commercial “stock exchanges”. BSE and NSE are some of them, though there are a number of other, smaller exchanges in India. An exchange provides a common place for people to buy or sell shares, with sales happening on an auction basis – buyers bid for shares at a price they are willing to pay, and sellers “ask” for a price from buyers. Exchanges match these prices and share exchanges happen along with payments. “Brokers” facilitate these exchanges, and you pay them a fee as brokerage, part of which goes to the stock exchange as well.

1. ORDINARY SHARES :
After the payment of fixed dividend to preference shareholders these participate in the remaining profit. Their profit is not fixed. They have no special rights in regard to profit.

2. DEFERRED SHARE :-
Generally these are issued to promoters of a company. The dividend on deferred share is paid after the payment of profit to all other kinds of shares.

3. PREFERRED SHARES :-
These shares are preferred on other shares. A fixed profit is paid first on these shares. These shareholders have some preferential rights on other shareholders. Following are important kinds of preference shares :

Cumulative preference share :- If in any year profits of the company are not enough to pay the dividend of cumulative preference shares, it continues accumulating until it is finally paid by the company.

Non cumulative preference shares :- If such shares profit is not paid in any year due to loss then it is never paid.

Guaranteed preference shares :-These are those shares which another company takes guarantee of payment of a fixed profit and repayment of capital.

Redeemable preferences shares :- Such shares are fully paid up before redemption. The repayment of these shares made by issuing fresh shares or by creating Reserve Fund. These are payable after a certain period.

Participating preference shares :- These shareholders are entitled to receive profit at a fixed rate and they also participate in the further surplus profit.

 

Types of Share Capital:

(i) Authorized, registered or nominal capital:

This is the amount of capital with which the company intends to get itself registered. This is the amount of share capital which a company is authorized to issue. Nominal capital is divided into shares of a fixed amount. It must be set out in the memorandum of association. It can be increased or decreased by following the prescribed procedure.

(ii) Issued capital:

It is that part of the nominal capital which is actually issued by the company for public subscription. A company need not issue the entire authorized capital at once. It goes on raising the capital as and when the need for additional funds is felt.

The difference between the nominal and the issued capital is known as ‘unissued capital’, which can be issued to the public at a later date. Where the whole of authorized capital is offered to the public, the authorized and issued capital will be the same. Issued Capital cannot be more than the authorized capital. Issued capital includes the shares allotted to public, vendors, signatories to memorandum of association etc.

(iii) Subscribed capital:

ADVERTISEMENTS:

 

It is that amount of the nominal value of shares which have actually been taken up by the public. It is that part of the nominal capital which has actually been taken up by shareholders who have agreed to give consideration in kind or in cash for shares issued to them. Where shares issued for subscription are wholly subscribed for, issued capital would mean the same thing as ‘subscribed capital’. That part of issued capital which is not subscribed by the public is called ‘Unsubscribed Capital’. Subscribed capital cannot be more than issued capital.

Example:

A company was incorporated with capital f 9, 00,000 divided in to Rs.90,000 equity shares of f Rs. 10 each. It issued, 70,000 shares to the public.

The public subscribed for:

(a) 50,000 shares

(b) 70,000 shares

(c) 75,000 shares.

Apart from the above 5,000 shares are issued to vendor as fully paid. What will be amount of different capitals?

Solution:

Authorized Capital Since the company is incorporated i.e. registered with capital of Rs.9,00,000 divided into shares of Rs.10 each. Therefore, the authorized capital is Rs. 9,00,000 (90,000 shares of Rs .10 each).

Issued Capital:

The company issued 70,000 shares of Rs. 10 each to public which means Capital of Rs. 7, 00,000 (i.e. 70,000 shares x 10 each). It also issued 5,000 shares of Rs. 10 each fully paid to vendor which means capital of Rs .50, 000.

Total Issued capital = Rs. 7, 50,000

Unissued Capital:

It is that part of authorized capital which has not been issued. In this case out of total authorized capital of Rs. 9, 00,000, Rs 7, 50,000 capital has been issued. The balance left Rs 1, 50,000 is unissued capital.

Subscribed capital:

(a) Public has subscribed for 50,000 shares of Rs 10 each. Therefore, subscribed capital is Rs. 5, 00,000.

Unsubscribed Capital:

In this case it will be the difference between the shares issued to the public and shares subscribed by the public. This difference is Rs 2,00,000 i.e. Rs 7,00,000— Rs 5,00,000, it is unsubscribed capital.

(b) Public has subscribed for 70,000 shares of Rs 10 each. Therefore, subscribed capital is Rs 7, 00,000 since subscribed capital is equivalent to issued capital, therefore, there is No unsubscribed capital.

(c) In this case public has subscribed for 75,000 shares of Rs 10 each. It is important to note that subscribed capital cannot be more than the issued capital. Hence, the subscribed capital in this case will be equivalent to issued capital of Rs 7,00,000. There is no unsubscribed capital in this case.

(iv) Called up capital:

The amount due on the shares subscribed may be collected from the shareholders in installments at different intervals. Called up capital is that amount of the nominal value of shares subscribed for which the company has asked its shareholders to pay by means of calls or otherwise.

If 10,000 shares of Rs 100 each have been subscribed by the public, and the company has asked the shareholders to pay Rs 10 on application, Rs. 20 on allotment and Rs 30 on first call, then the called up capital of the company would be Rs. 6, 00,000 (i.e. 10,000 x 60). The remaining amount i.e. Rs. 40 per share on 10,000 shares (i.e. Rs 4, 00,000) would be the uncalled capital of the company.

(v) Paid up capital:

That part of the called up capital which is actually paid up by the members is known as the paid up capital. In other words, paid up capital represents the total payments made by the shareholders to the company in response to the calls made by the company. Paid up capital of the company is calculated by deducting the calls in arrears from the called up capital.

Paid up capital = Called up capital Less Calls-in-arrears:

If in the above example, out of 10,000 shares of Rs 100 each, on which Rs 60 has been called by the company from the shareholders, one shareholder, holding 100 shares, fails to pay the first call of Rs 30 per share on his shares, the paid up capital of the company would be Rs 6, 00,000— Rs 3,000 i.e. Rs 5, 97,000.

 

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