Mutual Funds and Financial Derivatives

If you find it difficult or cumbersome to invest directly in equity shares and debt instrument you can invest in these financial assets indirectly though a mutual fund. A mutual fund represents a vehicle for collective investment. When you participate in a scheme of a mutual fund, you become a part-owner if the investment held under that scheme.

Till 1986 the Unit Trust of India was the only mutual fund in India offering a small number of schemes. As the mutual fund sector was liberalized new entrants came into the field. At present, there are about 30 mutual funds companies offering over 1000 schemes.

In India, the following entities are involved in a mutual fund operation: the sponsor, the mutual fund, the trustees, the asset management company (AMC), the custodian and the registrars and transfer agents Mutual fund schemes invest in three broad categories of financial assets, viz. stocks bonds and cash. Stocks refer to equity and equity related instruments. Bonds are debt instruments that have a maturity of more than one year. Cash represents bank deposits and debt instruments that have a maturity of less than one year.

Depending on the asset mix, mutual fund schemes are classified into three broad types, viz., equity schemes, hybrid schemes and debt schemes. Equity schemes invest the bulk of their corpus, 85-95 percent or even more, in stocks and the balance in cash. Hybrid schemes also referred to as balanced schemes invest in a mix of stocks and debt instruments. Debt schemes invest in bonds and cash. Within each of these broad categories, there are several variants as shown in the accompanying box.

Mutual funds in India are comprehensively regulated under the SEBI (Mutual Funds) Regulation, 1996. Some of the important provisions of this regulation are as follows:

* A mutual fund shall be constituted in the form of a trust executed by the sponsor in favor of the trustees;
* The sponsor or, if so authorized by the trust deed, the trustees shall appoint an asset management company.
* The mutual fund shall appoint a custodian
* No scheme shall be launched by the AMC unless it is approved by the trustees and a copy of the offer documents has been filed with SEBI
* The offer document and advertisement materials shall not be misleading
* No guaranteed return shall be provided in schemes unless such returns are fully guaranteed by the sponsor or the AMC.
* The moneys collected under any scheme of a mutual fund shall be invested only in transferable securities.
* The money collected under any money market scheme of a mutual fund shall be invested only in money market instrument in accordance with directions issued by the Reserve Bank of India.
* The mutual fund shall not borrow except to meet temporary liquidity needs.
* The net asset value (NAV) and the sale and repurchase price of mutual fund schemes must be regularly published in daily newspapers
* Every AMC shall keep and maintain proper books of accounts, records, and documents for each scheme.
* The investments of a mutual fund are subject to several restrictions relating to exposure to stocks of individual companies, debt instruments of individual issuers so on and so forth.
* Costs associated with mutual fund investing such as initial expenses loads (entry and exit), and annual recurring expenses are subject to certain ceilings.

A derivative is an instrument whose value depends on the value of some underlying asset. Hence, it may be viewed as a side bet on that asset. From the point of view of investors and portfolio managers, future and options are the two most important financial derivatives. They are used for hedging and speculation. Trading in these derivatives has begun in India.

Futures: A futures contract is an agreement between two parties exchange an asset for cash at a predetermined future date for a price that is specified today. The party which agrees to purchase the asset is said to have a long position and the party which agrees to sell the asset is said to have a short position.