ASSIGNMENT- A
Attempt these five analytical questions
Q1. What do you understand by financial system of a country? Explain its definition, significance and structure?
Q2. “Financial Markets are an important component of the financial system”, what are different types of financial markets? Explain
Q3. What are characteristics and functions of financial markets?
Q4. What are money market instruments? Explain
Q5. What are bonds? Explain their features. How are they different from debentures?
Assignment B
Q1. How are primary market and secondary market different from each other? Explain
Q2. What are mutual funds? Explain the benefit and risks involved in investing in Mutual Funds.
Q3. Write Short notes on:
a) FDI
b) NBFC
CASE STUDY
The US-64 Controversy
“They have cheated us. I am telling everyone to sell. If they are stupid and offering Rs 14.25 for paper worth Rs 9, why should I let go of the opportunity?”
– An unhappy US-64 investor in 1998.
CAN OF WORMS
In 1998, investors of Unit Trust of India’s (UTI) Unit Scheme-1964 (US-64) were shaken by media reports claiming that things were seriously wrong with the mutual fund major. For the first time in its 32 years of existence, US-64 faced depleting funds and redemptions exceeding the sales. Between July 1995 and March 1996, funds declined by Rs 3,104 crore. Analysts remarked that the depleting corpus coupled with the redemptions could soon result in a liquidity crisis.
Soon, reports regarding the lack of proper fund management and internal control systems at UTI added to the growing investor frenzy. By October 1998, US-64’s equity component’s market value had come down to Rs 4200 crore from its acquisition price of Rs 8200 crore. The net asset value (NAV) of US-64 also declined significantly during 1993-1996 due to turbulent stock market conditions. A Business Today survey cited US-64’s NAV at Rs 9.68. The US-64 units, which were sold at Rs 14.55 and repurchased at Rs 14.25 in October 1998, thus were around 50% and 47%, above their estimated NAV.
Amidst growing concerns over the fate of US-64 investors, it became necessary for UTI to take immediate steps to put rest to the controversy.
CREATING TRUST
UTI was established through a Parliament Act in 1964, to channelise the nation’s savings via mutual fund schemes. This was done as in the earlier days, raising the capital from markets was very difficult for the companies due to the public being very conservative and risk averse. By February 2001, UTI was managing funds worth Rs 64,250 crore through over 92 saving schemes such as US-64, Unit Linked Insurance Plan, Monthly Income Plan etc. UTI’s distribution network was well spread out with 54 branch offices, 295 district representatives and about 75,000 agents across the country.
The first scheme introduced by UTI was the Unit Scheme-1964, popularly known as US-64. The fund’s initial capital of Rs 5 crore was contributed by Reserve Bank of India (RBI), Financial Institutions, Life Insurance Corporation (LIC), State Bank of India (SBI) and other scheduled banks including few foreign banks. It was an open-ended scheme , promising an attractive income, ready liquidity and tax benefits. In the first year of its launch, US-64 mobilized Rs 19 crore and offered a 6.1% dividend as compared to the prevailing bank deposit interest rates of 3.75 – 6%. This impressed the average Indian investor who until then considered bank deposits to be the safest and best investment opportunity. By October 2000, US-64 increased its capital base to Rs 15993 crore, spread over 2 crore unit holders all over the world.
However by the late 1990s, US-64 had emerged as an example for portfolio mismanagement. In 1998, UTI chairman P.S.Subramanyam revealed that the reserves of US-64 had turned negative by Rs 1098 crore. Immediately after the announcement, the Sensex fell by 224 points. A few days later, the Sensex went down further by 40 points, reaching a 22-month low under selling pressure by Foreign Institutional Investors (FIIs). This was widely believed to have reflected the adverse market sentiments about US-64. Nervous investors soon redeemed US-64 units worth Rs 580 crore. There was widespread panic across the country with intensive media coverage adding fuel to the controversy.
DISTRUST IN TRUST
Unlike the usual practice for mutual funds, UTI never declared the NAV of US-64 – only the purchase and sale prices for the units were announced. Analysts remarked that the practise of not declaring US-64’s NAV in the initial years was justified as the scheme was formulated to attract the small investors into capital markets. The declaration of NAV at that time would not have been advisable, as heavy stock market fluctuations resulting in low NAV figures would have discouraged the investors. This seemed to have led to a mistaken feeling that the UTI and US-64 were somehow immune to the volatility of the Sensex.
Following the heavy redemption wave, it soon became public knowledge that the erosion of US-64’s reserves was gradual. Internal audit reports of SEBI regarding US-64 established that there were serious flaws in the management of funds.
Till the 1980s, the equity component of US-64 never went beyond 30%. UTI acquired public sector unit (PSU) stocks under the 1992-97 disinvestment program of the union government. Around Rs 6000-7000 crore was invested in scripts such as MTNL, ONGC, IOC, HPCL & SAIL.
A former UTI executive said, “Every chairman of the UTI wanted to prove himself by collecting increasingly larger amounts of money to US-64, and declaring high dividends.” This seemed to have resulted in US-64 forgetting its identity as an income scheme, supposed to provide fixed, regular returns by primarily investing in debt instruments.
Even a typical balanced fund (equal debt and equity) usually did not put more than 30% of its corpus into equity. A Business Today report claimed that eager to capitalise on the 1994 stock market boom, US-64 had recklessly increased its equity holdings. By the late 1990s the fund’s portfolio comprised around 70% equity.
While the equity investments increased by 40%, UTI seemed to have ignored the risk factor involved with it. Most of the above investments fared very badly on the bourses, causing huge losses to US-64. The management failed to offload the equities when the market started declining. While the book value of US-64’s equity portfolio went up from Rs 7,943 crore (June 1994) to Rs 13,627 (June 1998), the market value had actually declined in the same period from Rs 18,334 crore to Rs 10,029 crore. Analysts remarked that UTI had been pumping money into scrips whose market value kept falling. Raising further questions about the fund management practices was the fact that there were hardly any ‘growth scrips’from the IT and pharma sectors in the equity portfolio.
In spite of all this, UTI was able to declare dividends as it was paying them out of its yearly income, its reserves and by selling the stocks that had appreciated. This kept the problem under wraps till the reserves turned negative and UTI could no longer afford to keep the sale and purchase prices artificially inflated.
Following the public outrage against the whole issue, UTI in collaboration with the government of India began the task of controlling the damage to US-64’s image.
RESTORING THE TRUST
UTI realised that it had become compulsory to restructure US-64’s portfolio and review its asset allocation policy. In October 1998, UTI constituted a committee under the chairmanship of Deepak Parekh, chairman, HDFC bank, to review the working of scheme and to recommend measures for bringing in more transparency and accountability in working of the scheme.
US-64’s portfolio restructuring however was not as easy as market watchers deemed it to be. UTI could not freely offload the poor performing PSU stocks bought under the GoI disinvestment program, due to the fear of massive price erosions after such offloading. After much deliberation, a new scheme called SUS-99 was launched.
The scheme was formulated to help US-64 improve its NAV by an amount, which was the difference between the book value and the market value of those PSU holdings. The government bought the units of SUS-99 at a face value of Rs 4810 crore. For the other PSU stocks held prior to the disinvestment acquisitions, UTI decided to sell them through negotiations to the highest bidder. UTI also began working on the committee’s recommendation to strengthen the capital base of the scheme by infusing fresh funds of Rs 500 crore. This was to be on a proportionate basis linked to the promoter’s holding pattern in the fund.
The inclusion of the growth stocks in the portfolio was another step towards restoring US-64’s image. Sen, Executive Director, UTI said, “The US-64 equity portfolio has been revamped since June. During the last nine months the new ones that have come to occupy a place among the Top 20 stocks from the (Satyam Computers, NIIT and Infosys) and FMCG (HLL, SmithKline Beecham and Reckitt & Colman) sectors. US-64 has reduced its weightage in the commodity stocks (Indian Rayon, GSFC, Tisco, ACC and Hindalco.)”
To control the redemptions and to attract further investments, the income distributed under US-64 was made tax-free for three years from 1999. To strengthen the focus on small investors and to reduce the tilt towards corporate investors, UTI decided that retail investors should be concentrated upon and their number should be increased in the scheme.
UTI also decided to have five additional trustees on its board. To enable trustees to assume higher degree of responsibility and exercise greater authority UTI decided to give emphasis on a proper system of performance evaluation of all schemes, marked-to-market valuation[5] of assets and evaluation of performance benchmarked to a market index. The management of US-64 was entrusted to an independent fund management group headed by an Executive Director. UTI made plans to ensure that full responsibility and accountability was achieved with support of a strong research team. Two independent sub-groups were formed to manage the equity and debt portion of US-64. An independent equity research cell was formed to provide market analysis and research reports.
TABLE I
HOW THINGS WERE SET RIGHT
• PSU shares were transferred to a special unit scheme (SUS’99) subscribed by the government in 1998-99.
• Core promoters such as the Industrial Development Bank of India added around Rs 450 crore to the unit capital, thus helping to bridge the reserves deficit of Rs 2,800 crore in 1998-99.
• Portfolios were recast in the current quarter to capitalise on the stock surge as the BSE Sensex rose by 15%. Greater weightage was given to stocks such as HLL, Infosys, Ranbaxy, M&M and NIIT.
• In US-64’s case exposure to IT, FMCG and Pharma stocks rose from 20.45% to 22.09%. This was replicated across funds. Between June 1999 – September 1999, 21 out of UTI’s 28 schemes have outperformed the Sensex.
• UTI has become more proactive in fund management. For instance, it bought into Crest at between
• Rs 200 and Rs 210 in October 1999. The stock was trading at Rs 340 in November 1999.
• Stocks like Visual Software, Mastek and Gujarat Ambuja have entered the top 50 equity holding list. Scrips like Thermax, Thomas Cook and Carrier Aircon are out.
• Complete exit from illiquid stocks such as Esab Industries. The divesture of around 83 stocks released estimated Rs 300-500 crore of extra investible cash.
Source: Business World, November 29, 1999.
UTI constituted an ad-hoc Asset Management Committee with 7 members comprising 5 outside professionals and 2 senior UTI officials. The committee’s role was clearly defined and its scope covered the following areas:
• To ensure that US-64 complied with the regulations and guidelines and the prudential investment norms laid down by the UTI board of trustees from time to time.
• To review the scheme’s performance regularly and guide fund managers on the future course of action to be adopted.
• To oversee the key issues such as product designing, marketing and investor servicing along with the recommendations to Board of Trustees.
One of the most important steps taken was the initiative to make US-64 scheme NAV driven by February 2002 and to increase gradually the spread between sale and repurchase price. The gap between sale and repurchase price of US-64 was to be maintained within a SEBI specified range. UTI announced that dividend policy of US-64 would be made more realistic and it would reflect the performance of the fund in the market. US-64 was to be fully SEBI regulated scheme with appropriate amendment to the UTI Act.
The real estate investments made by UTI for the US-64 portfolio were also a part of the controversy as they were against the SEBI guidelines for mutual funds. UTI had Rs 386 crore worth investments in real estate. UTI claimed that since its investments were made in real estate, it was safe and it could sell the assets whenever required. However, the value of the real estate in US-64’s portfolio had gone down considerably over the years. The real estate investments were hence revalued and later transferred to the Development Reserve Fund of the trust according to the recommendations of the Deepak Parekh committee.
By December 1999, the investible funds of US-64 had increased by 60% to Rs 19,923 crore from Rs 12,433 crore in December 1998. The NAV had recovered from Rs 9.57 to Rs 16 by February 2000 after the committee recommendations were implemented
DEAD END SCHEME?
Though UTI started announcing the dividends according to the market conditions, this was not received well by the investors. They felt that though the dividend was tax-free, it was not appealing as most of the investors were senior citizens and they did not come under the tax bracket.
The statement in media by UTI chairman that trust would try to attract the corporate investors into the scheme was against the recommendation by the committee, which had adviced the trust to attract the retail investors into the scheme. This led to doubts about UTI’s commitment towards the revival of the scheme.
However, led by improving NAV figures and image-building exercises on UTI’s part, by 2000, US-64 was again termed as one of the best investment avenues by analysts and market researchers. UTI had become more proactive in fund management with its scrips rising in value, restoring the confidence of the small investor in the scheme. The National Council of Applied Economic Research (NCAER) and SEBI surveys mentioned that US-64 was once again perceived as a safe investment by the middle class income groups.
However, the euphoria seemed to be short lived as in 2001, US-64 was involved in yet another scam due to its investments in the K-10 stocks . Talks of a drastically low NAV, inflated prices, increasing redemption and GoI bailouts appeared once again in the media. An Economic Times report claimed that there was a difference of over Rs 6000 crore between the NAV and the sale prices. Doubts were raised as to US-64 being an inherently weak scheme, which coupled with its mismanagement, had led to its downfall once again.
This however, was yet another story.
Source: icmrindia dot org
QUESTIONS FOR DISCUSSION:
1. Explain in detail the reasons behind the problems faced by US-64 in the mid 1990s. Were these problems the sole responsibility of UTI? Give reasons to support your answer.
2. Analyse the steps taken by UTI to restore investor confidence in US-64. Comment briefly on the efficacy of these steps.
3. As a market analyst, would you term US-64 a safe mode of investment? Justify your stand with reasons.
ASSIGNMENT –C
MULTIPLE CHOICE QUESTIONS
Q1. Equity shareholder’s rights are listed below. One of the rights is incorrect.
(a) rights to have first claim in the case of winding of the company
(b) right to vote at the general body meeting of the company
(c) right to share profits in the form of dividends
(d) right to receive a copy of the statutory report
Q2. In the case of non voting shares:
(a) the rights of voting stocks and non voting stocks are similar
(b) rights and bonus issues for non voting shares can be issued in the form of voting shares
(c) the non voting shares would become voting shares after a particular period of time
(d) non voting shares carry higher dividends instead of voting rights
Q3. NBFC’s offer higher interest rate because of
(a) the best management funds
(b) the competition among the NBFC’s
(c) the risk involved
(d) the credit rating
Q4. Primary and Secondary markets
(a) compete with each other
(b) complement each other
(c) function independently
(d) control each other
Q5. The underwriter has to take up
(a) the fixed portion of issued capital
(b) the agreed portion of the unsubscribed part
(c) the agreed portion or can refuse it
(d) none of the above
Q6. Book Building is a
(a) method of placing an issue
(b) method of entry in foreign market
(c) price discovery mechanism in case of an IPO
(d) none of the above
Q7. “Sell Reliance Petro Shares at Rs 60” This order is a
(a) Best rate order
(b) Limit order
(c) Discretionary order
(d) Stop Loss Order
Q8. Stock exchange helps in
(a) fixation of stock prices
(b) ensures safe and fair dealing
(c) induces good performance by the company
(d) all of the above
Q9. In a limit order
(a) Orders are limited by a fixed price
(b) Investor gives a range of price for purchase and sale
(c) Order is given but to a limit a loss
(d) None of the above
Q10. Which one of these is not true for a broker?
(a) Broker has to abide by the code of conduct laid down by security exchange commission
(b) Broker facilitates the secondary market operations
(c) Broker is a bridge between stock market and investor
(d) Broker should leak the inside information of stock exchange
Q11. FII’s are permitted
(a) To invest in listed companies only
(b) To invest in listed and unlisted companies
(c) Not to invest in debentures
(d) To invest in shares of listed unlisted companies and debentures.
Q12. Marketability risk of Bond is
(a) The market risk which affects all the bonds
(b) Variation in return caused by difficulty in selling bonds
(c) The failure to pay the agreed value of the bond by the issuer
(d) (a) and (b) both.
Q13. The value of bond depends on
(a) Coupon rate
(b) Years to maturity
(c) Expected yield to maturity
(d) All of the above
Q14. Forex market deals with
(a) multi currency
(b) only domestic currency
(c) none of the above
Q15. Credit market is a place here
(a) multi currency requirements are met
(b) Long term financing is done
(c) Banks, Financial Institutions and NBFC’s lend short medium and long term loans to corporate or individuals
(d) None of the above
Q16. Money Market is a
(a) retail market
(b) wholesale market
(c) retail and whole sale market
(d) none of the above
Q17. What is true for call money?
(a) Money is borrowed for a fortnight
(b) Money is borrowed for a week
(c) Money is borrowed for a day
(d) None of the above
Q18. When money is borrowed or lent for more than a day and up to 14 days it is called
(a) Call money
(b) Quick money
(c) Notice money
(d) Term money
Q19. Mutual funds are valued with help of their
(a) NAV’s
(b) NFO
(c) IPO
(d) None of the above
Q20. Which one of the following is true
(a) Primary market gives liquidity to secondary market
(b) Secondary market gives liquidity to primary market
Q21. Right issue is:
(a) issue of securities by issue of prospectus to the public
(b) Securities are issued through some selected investors.
(c) Selling securities in the primary market by issuing rights to the existing shareholders.
(d) None of the above
Q22. Private placement has following advantage:
(a) Flexibility and high cost
(b) Accessibility and speed
(c) High cost and speed
(d) Speed and complexity
Q23. Book Building Process is completed with the help of a
(a) Book runner
(b) Underwriter
(c) Registrar
(d) Lead manager
Q24. Treasury bills are issued
(a) on discount
(b) at premium
Q25. Commercial papers are
(a) Secured Promissory Note
(b) Unsecured Promissory note
(c) Issued by individuals
(d) None of the above
Q26. Total amount of called up share capital which is actually paid to the company by the members is called
(a) Subscribed capital
(b) Called up capital
(c) Paid up share capital
(d) None of the above
Q27. A shares par value is Rs 10 but it is issued at Rs 20 , then extra amount over par value is called
(a) Coupon
(b) Interest
(c) Premium
(d) None of the above
Q28. “Bad news about a company can pull down its stock prices”. This is called
(a) Market risk
(b) Non market risk
(c) Interest risk
(d) Callable risk
Q29. Debt/Income funds invest in
(a) Tax saving schemes
(b) Money Market Instruments
(c) High Rate fixed income bearing instruments
(d) Both debt and equity
Q30. Mutual Funds investor can not earn following return
(a) Dividend
(b) Capital Gain
(c) Increase in NAV
(d) Fixed interest earning
Q31. Trustees in India are registered under
(a) Company’s Act 1956
(b) Indian Trust act 1882
(c) SEBI
(d) Central bank
Q32. Sweat Equity are the Equity Shares issued by company to its directors or employees.
(a) As salary
(b) As consideration
(c) Both of the above
(d) None of the above
Q33. “ Bond prices and interest rates move in opposite direction”
a) above statement is true
b) Above statement is false
c) Partially true
d) Partially false
Q34. Balanced funds provide:
(a) Steady return
(b) High return
(c) Increase volatility
(d) None of the above
Q35. Stock exchanges should ensure:
(a) Active trading and insider information
(b) Active trading and transparency
Which of the following is true?
(a) Both a and b
(b) Only b
(c) Only a
(d) Neither a nor b
Q36. Merchant bankers do not indulge in following activities
(a) Drafting of prospectus
(b) Appointment of Registrar
(c) Selection of Promoter
(d) Arrangement of underwriter
Q37. Private placement reduces ________________________ of public issue:
(a) Cost
(b) Subscription
(c) Issue size
(d) None of the above
Q38. NBFC can accept deposits form NRI’s
a) Above statement is true
b) Above statement is false
c) Partly true
d) None of the above
Q39. FDI is seen as a important source of capital formation when:
a) Capital base is low
b) Capital base is high
c) Economy is self sufficient
d) All of the above
Q40. Preference shares means which fulfill the following two conditions
a) It carries preferential rights in respect of dividend at fixed amount and fixed rate
b) It does not carry preferential rights in regard to payment of capital on winding up .
WHICH ONE OF THESE IS TRUE:
(a) Both a and b
(b) Only a
(c) Only b
(d) Neither a nor b