Inv MGMT II 657 v1

Investment Management – II
Sub Code - 657
Developed by
Prof. Ajay Prabhu
On behalf of
Prin. L.N. Welingkar Institute of Management Development & Research
!  
Advisory Board
Chairman
Prof. Dr. V.S. Prasad
Former Director (NAAC)
Former Vice-Chancellor
(Dr. B.R. Ambedkar Open University)
Board Members
1. Prof. Dr. Uday Salunkhe  2. Dr. B.P. Sabale  3. Prof. Dr. Vijay Khole  4. Prof. Anuradha Deshmukh 
Group Director  Chancellor, D.Y. Patil University, Former Vice-Chancellor  Former Director 
Welingkar Institute of Navi Mumbai  (Mumbai University) (YCMOU)
Management Ex Vice-Chancellor (YCMOU)
Program Design and Advisory Team
Prof. B.N. Chatterjee Mr. Manish Pitke

Dean – Marketing Faculty – Travel and Tourism
Welingkar Institute of Management, Mumbai Management Consultant
Prof. Kanu Doshi Prof. B.N. Chatterjee

Dean – Finance Dean – Marketing
Welingkar Institute of Management, Mumbai Welingkar Institute of Management, Mumbai
Prof. Dr. V.H. Iyer Mr. Smitesh Bhosale

Dean – Management Development Programs Faculty – Media and Advertising
Welingkar Institute of Management, Mumbai Founder of EVALUENZ
Prof. B.N. Chatterjee Prof. Vineel Bhurke

Dean – Marketing Faculty – Rural Management
Prof. Venkat lyer Dr. Pravin Kumar Agrawal

Director – Intraspect Development Faculty – Healthcare Management
Manager Medical – Air India Ltd.
Prof. Dr. Pradeep Pendse Mrs. Margaret Vas

Dean – IT/Business Design Faculty – Hospitality
Welingkar Institute of Management, Mumbai Former Manager-Catering Services – Air India Ltd.
Prof. Sandeep Kelkar Mr. Anuj Pandey

Faculty – IT Publisher
Welingkar Institute of Management, Mumbai Management Books Publishing, Mumbai
Prof. Dr. Swapna Pradhan Course Editor

Faculty – Retail Prof. Dr. P.S. Rao
Welingkar Institute of Management, Mumbai Dean – Quality Systems
Welingkar Institute of Management, Mumbai
Prof. Bijoy B. Bhattacharyya Prof. B.N. Chatterjee

Dean – Banking Dean – Marketing
Mr. P.M. Bendre Course Coordinators

Faculty – Operations Prof. Dr. Rajesh Aparnath
Former Quality Chief – Bosch Ltd. Head – PGDM (HB)
Welingkar Institute of Management, Mumbai
Mr. Ajay Prabhu Ms. Kirti Sampat

Faculty – International Business Assistant Manager – PGDM (HB)
Corporate Consultant Welingkar Institute of Management, Mumbai
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Ex Senior V.P. (Sify) Welingkar Institute of Management, Mumbai
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1st Edition, May 2019

CONTENTS
Contents
Chapter No. Chapter Name Page No.
1 Introduction to Investment Management 4-24

2 Investing in Debt Instruments 25-63
3 Investment in Bank Deposits 64-112
4 Post Office Investment Schemes 113-135
5 Company Deposits Nidhis and Chitfunds 136-225
6 Collective Investment Schemes 226-290
7 Exotic Investments 291-319
8 Modern Investment Alternatives 320-352
9 Alternate Forms of Investments 353-378
10 Investment in Foreign Companies 379-394
! !3
INTRODUCTION TO INVESTMENT MANAGEMENT
Chapter 1
Introduction to Investment Management
Objectives:
This chapter will help you understand basic objectives of investment,

difference between savings and investing, wide range of investment
choices, different modes of making investment, factors affecting
investment, risk return relationship and portfolio management.
Structure:
1.1 Introduction
1.2 Difference between Savings and Investing
1.3 Objectives of Investment
1.4 The Nature of Investment
1.5 Wide Range of Investment Choices
1.6 Factors Affecting Investments
1.7 Difference between Investment, Speculation and Gambling
1.8 Investment Risk
1.9 Portfolio Management
1.10 Activities for Students
1.11 Summary
1.12 Self Assessment Questions
1.13 References
! !4
1.1 Introduction
Money is required at each and every stage of our life to fulfill our needs
and goals. Increasing human wants, longer life spans and huge number of
opportunities to spend have made wise investments an essential tool to
generate an excellent return and securing future. A wealthy person is one
who knows the art of preserving and growing wealth. Investment
management helps individuals and institutions to secure and increase their
wealth, while offering traditional and alternative investments.
Good investors do not just work hard to earn money, but also make money
work for them. Good investors are also able to maintain their financial
stability and take care about themselves in case of financial crisis.
Warren Buffet Says
“To invest successfully over a life time does not require a stratospheric IQ,
unusual business insights, or inside information. What’s needed is a sound
intellectual framework for making a decision and the ability to keep
emotions from corroding the framework”.
Investing can be both rewarding and enjoyable experience if the investor

adheres to the cardinal principles of investment management.
1.2 Difference between Savings and Investing
For a layperson, savings means the money that remains after satisfying the
immediate consumption requirements. Savings refer to money you put
aside for future use rather than spending it immediately for current
consumption. However, most people are not able to save as rising income
is often accompanied by increased expenses.
The fundamental psychological law propounded by John Meynard

Keynes asserts that individuals on an average increase their consumption
as their income increases, but not by as much as the increase in their
income.
! !5
Savings is simple but not easy. Every individual should have some motive
in order to save for meeting financial goals. IT IS NOT HOW MUCH
MONEY YOU MAKE: IT IS HOW MUCH MONEY YOU KEEP. The simplest
part of saving is to first keep aside some part of your money to save and
then spend the left out, rather than first spend and then spend the left out.
Strategy to Save
Ideally, the best savings equation should be: Income – Savings =

Investments
and NOT: Income – Expenses = Savings
Unfortunately deployment of this simple savings strategy is not

easy, as most people want to spend first and then save. They don’t have
control on their desires. They hardly have patience and discipline to make
their savings grow over a longer time horizon.
According to Modigliani’s Life Cycle Theory people make intelligent

choices about their spending at each age, limited by the resources
available over their lives.
Investment means the utilization of the money that is saved.

Warren Buffet beautifully defines investment as “laying out money today to
receive more money tomorrow.”
Investment in broader terms means putting the money saved in income or

growth asset in order to generate returns for fulfilling financial goals.
Investment always accompanies with return generation for achieving
financial goals.
Savings are generally for short term, while investments can be for both
short term and long term. Savings generally involves minimal risk, but in
the case of investments risks can be higher. 
! !6
Savings Investment
First step to put aside money for future One step further to savings for
use generating returns
Savings alone cannot increase wealth Investments can increase wealth
It is a part of income, which is not Results into purchase of an asset to

used in consumption enhance the savings
One saves by reducing present One invests by sacrificing the

consumption enjoyment on consumption
May not generate returns Mostly generates returns(positive or
negative)
Intended to meet financial goals Involves risk diversification and

meeting financial goals
Creating a corpus for investment is the Return on investment is the key driving
key driving force behind investment force behind investing
Saving is risk less and very safe Investment involves risk

commensurate with the potential to
grow over time
Meant for dealing with emergency Meant for long term and designed to
situations and meet unexpected provide returns and grow money over
expenses a period of time.
Highly liquid as they can be accessed Less liquid as some time/ few days
at any time may be required for crediting sale
proceeds on redemption.
! !7
1.3 Objectives of Investment
An investment is made to accomplish an objective for an investor.

Investment objectives are carved out of investors life stage and risk
appetite to achieve life’s major financial goals such as higher education, a
house, a car, marriage, foreign tour, health care, dependent care and even
retirement planning.
Investment Financial Goals are Achieved by Optimizing Following

Investment Objectives:
1. Safety: The safest investments are expected to preserve the invested

capital, without worrying about the quantum of returns.
2. Growth: The growth options are aimed at increasing the capital with
higher returns
3. Liquidity: Results are in the form of quick conversion of investments

into cash, without/minimal impact on the capital/maturity proceeds.
4. Income stability and regularity of income after taxes
5. Legal safeguards and approval by law: assures return of money

invested
The basic purpose of defining investment objectives is to identify the

path needed by the investor to convert a dream into reality.
An investor cannot make the clock go back, but can certainly make wise
investment decisions today to make his future better. In the same vein, an
investors objectives can be fulfilled by selecting proper investment vehicles
to invest, as it does not take much time for erosion of money due to
money eating factors such as inflation, rising cost for meeting expenses
etc.
Inorder to select the right investment vehicles, an investor has to gain as

well as update knowledge about investments. Peter Drucker rightly says “
Knowledge has to be improved, challenged and increased constantly, or it
vanishes”. Similarly an investor should also be aware about how to make
smart goals with realistic objectives, with the changing times and
development of markets and economy.
! !8
1.4 The nature of Investment
The nature of investment is based on the investment objective of the

investor. Investments can imbibe the following nature based on the goals
of the investor.
One Time Investment: The coffecan approach involving invest and forget
and take whatever comes on maturity.
Regular Investment: Periodic investment to build a corpus required for

achieving financial goals.
Short Term Investment: For achieving financial goals within a period of 3

to 5 years.
Long Term Investment: For achieving financial goals after 5 years
1.5 Wide range of Investment choices
A diverse portfolio can certainly help to protect the wealth from market
volatility and uncertainty. Technological development and increase in
different types of financial markets and instruments has given wider range
of investment options to informed investors. Investors has various choices
for investments to choose from for accomplishing investment objectives
such as:
1. Fixed Income Investment: Confers creditorship on the investors.

Ideal for investors who are satisfied with investment in secured assets
promising fixed returns. Safety is the primary objective. Lesser returns
are acceptable to such type of risk averse investors. E.g. Interest
bearing Corporate/RBI/Government/ Municipal/infrastructure bonds,
Bank deposits etc.
2. Equity Investment: Confers ownership on the investor. Ideal for

investor who are willing to take risk and participate in a volatile market.
Returns are commensurate with the risk taken in investing. Such
investments can generate exponential return in a bull market and can
even wipe out the capital during financial crisis.
! !9
3. Bank deposits: In demand liabilities (savings account, current account)

and term liabilities (fixed deposit, recurring deposit, flexi deposit, cash
certificates, certificate of deposits). Demand libailities are preferred by
investors opting for liquidity, while investment in term liabilities is opted
by investors who are willing to invest for long term for getting higher
interest.
4. Post Office Investment schemes: The Central Government operates

Small Savings Schemes (SSS) in order to mobilise household savings
through:
a. Post office deposits: Savings account, Recurring deposits
b. Post office savings Certificates: National Savings Certificate(NSC),

Kisan Vikas Patra(KVP)
c. Post office social security schemes: Public Provident Fund(PPF),

Senior Citizens Savings Scheme, Sukanya Samriddhi Account,
Insurance
The best part of these investment is linking of interest rates to

government bond yields. Interest rates are reset every quarter based
on the average yield on government bonds of similar maturity in
previous quarter. Since the interest rate is formula driven, with rise in
yields, post office deposits ma fetch higher returns than bank deposits.
5. Company fixed deposits, Nidhis and Chit Funds
6. Collective investment schemes: Mutual Funds, ETFs
7. Exotic investments: Antiques, Art, farm houses, precious stones and

metals, vintage cars etc.
8. Modern investment alternatives: Index, Currencies and Commodities

with Futures, Options and Swaps
9. Investment in foreign markets: For those investors who want to

create a foreign portfolio
10.Alternative forms of Investments: ADRs, GDRs and IDRs
! !10
1.6 Factors affecting investments
Investments are based on investors approach to investing to suit lifestyle

needs and investment goals. Investments can be affected by various
factors such as nature of the investment asset class(internal factors),
external factors such as taxation, market volatility etc and even the
investors behavior. An aggressive investor is willing to take risk, while a
conservative investor never dares to take risk. Most younger investors
want growth and higher total returns. Senior citizens want consistent
monthly payouts from investment portfolio.
Technological changes create new conveniences, reduces costs and

succeeds in providing various flavors of investment vehicles.
Major Factors which can Affect Investments are as Follows
• Macro Economic Changes

• Regulatory Changes and fiscal policies
• Political Changes and Social Dynamics
• Market Volatility and interest rates
• Inflation and Tax rates
• Financial Illiteracy
• Emotions and behavioral finance
• Investment Discipline
• Clarity in financial planning and goals
• Fees & Charges
Before making any investment decision an investor should be first

equipped with information on various investment options, must have ready
access to various avenues of investment and then make investment
decisions based on proper analysis and evaluation of information.
Dependency on advice given by friends, brokers or financial intermediaries
may fail to critically evaluate finance decisions before taking investment
decisions.
! !11
1.7 Difference between Investment, Speculation and

Gambling
As per Benjamin Graham, an professional investor, investment is an

activity, which upon complete analysis assures the safety of the amount
invested and adequate return. Conversely, speculation is an activity which
does not satisfy these requirements.
High-risk trades are associated with speculation, whereas lower-risk

investments based on fundamentals and analysis represents the category
of investing. A gambler wants to make quick money and enjoys thrill and
excitement without worrying about the consequences. Speculations lasts
longer than gambles, but are shorter in duration than investments.
Investment Speculation Gambling
Long term Short term Quick gains through

chance decided in
seconds
Limited risk Moderate risk High risk
Consistent returns Higher returns and Higher returns or Higher

moderate losses losses
Own funds invested Borrowed money is Own or borrowed

generally invested
Decisions are based on Decisions are based on Decisions are based on

sound principles of market behavior and tips, rumors, non
investing analysis scientific methods and
hunches
! !12
1.8 Investment Risk
In economics and finance, risk means the possibility of loss due to change
in actual outcome of an action from the expected outcome. Investments
have to face various risk and hence an investor has to assess these risks
before investing and thereafter take suitable actions to minimize the
impact of risk by deploying appropriate strategies.
The response to risk varies based on human behavior, risk appetite and
tolerance, and the strategies used to either transfer risk, prevent risk,
mitigate risk or to accept risk. Risk is accepted or retained willingly only if
the expected profit from bearing the risk will compensate the investor from
risk exposure. Speculators are risk seekers and trade in the market to earn
profit from risky venture.
Investing can cause various risk right from its origination till expiry such
as:
a. Credit risk: Loss due to counterparty party failure to perform obligation
b. Market risk: Loss due to adverse changes in the market value
c. Liquidity risk: Failure of an institution to meet its funding requirement
d. Operational risk: Loss due to inadequate systems and control, human

error, management failure
e. Legal risk: Loss arising from legally non enforceable contracts
f. Regulatory risk: Loss arising from failure to comply with regulatory or

legal requirement
g. Reputation risk: Loss arising from adverse public opinion
h. Settlement risk: Arises as a result of the timing differences between

when an institution either pays out funds or deliverables assets before
receiving assets or payments from a counterparty and it occurs at a
specific point in the life of the contract.
! !13
i. Strategic risk: Arises from activities such as entrepreneurial behavior

of traders in financial institutions, misreading client requests, costs
getting out of control, trading with inappropriate counterparties etc
j. Systemic risk: Arises when there is a failure of large and complex

organization of financial positions in the economy.
k. Technology risk: Risk has increased due to increased use of

technology. Increased sophistication and new information technology
have created complications and insecurity.
Risk of individual assets is measured by their variance or standard

deviation. The types of risk bond investors face include interest rate risk,
default risk, inflation risk, reinvestment risk, liquidity risk, ratings risk and
underwriting risk. Equity risk is "the financial risk involved in holding equity
in a particular investment.
The risk of portfolio would be less than the risk of individual securities, and
that the risk of a security should be judged by its contribution to the
portfolio risk. Managing a portfolio is essentially a process of balancing
expected risks and expected returns. Allocation of investment between
risky and relatively less risky asset classes makes it smoother for the
investor to fulfill his financial goals.
Asset Allocation Strategies
a. Integrated Asset Allocation: Asset allocation is based on capital

market conditions and investor objectives and constraints. The
allocation that best serves the investor’s needs is chosen.
b. Strategic Asset Allocation: Asset allocation is based on optimal

portfolio mixes based on returns, risk, and co-variances. Allocation is
adjusted periodically to restore target allocation within the context of
the investor’s objectives and constraints.
c. Tactical Asset Allocation: Asset allocation is based on investor’s risk

tolerance and the asset allocation is changed based on expectations
about capital market conditions.
! !14
Risk management requires a systematic and logical approach to minimize

and mitigate the impact of risk. Risk management strategies comprises of
identification of probability, analysis in terms of frequency and severity,
assessment in terms of scope of loss, measurement in terms of financial
and non financial loss, and control of risk through prevention through
appropriate mechanism, reduction if unpreventable to reduce loss, transfer
through insurance or outsourcing, retention by dealing with it and
avoidance by eliminating the risk.
1.9 Portfolio Management
Portfolio management comprises all the processes involved in the creation

and maintenance of an investment portfolio. It deals specifically with
security analysis, portfolio analysis, portfolio selection, portfolio revision
and portfolio evaluation.
It also makes use of analytical techniques of analysis and conceptual

theories regarding rational allocation of funds. Portfolio theories guides
investors about the method of selecting and combining securities that will
provide the highest expected rate of return for any given degree of risk or
that will expose the investor to the lowest degree of risk for a given
expected rate of return.
Security analysis constitutes the initial phase of the portfolio

formation process and consists in examining the risk-return
characteristics of individual securities and also the correlation among them.
An investor has to choose worthwhile securities from a vast number of
securities. This requires a detailed analysis of the all securities available for
making investment.
Every person has to pass through different stages of his life from birth till
death. Someone in their thirties will have different needs to someone in
their sixties. Market research shows that life stages has a strong impact on
how consumers decide on investing.
Security analysis provides the investor with a set of worthwhile or desirable

securities based on different life stages. The return and risk of each
portfolio has to be computed mathematically and expressed quantitatively
along with pair-wise correlations among them.
! !15
Different Investments with Different Risk and Return
Security Risk Return
Government Bonds Lowest Low
Post Office deposits Low Moderate returns
Debt funds Moderate Moderate returns
Real Estate Fairly risky Capital gains
Equity Risky High returns
Derivatives Highly risk Highest returns/losses
Stages of Financial Life Cycle
1. Toddler (0-5): Early childhood: Parents take care of all requirements

and plan for future requirements of the child.
2. Childhood (Age 6-12): Parent introduce piggy bank concept to teach

new concepts of accumulation and understand the real value of money.
3. Teenage Years (Age 12-19): Budgeting concept is introduced to

spend wisely on pocket money/earned income, and investing for making
money work.
4. Early job/business (During 20’s): Best time to start saving for

building wealth in the long-term and dealing with financial emergencies
by investing 75% of income in Equity and 25% in interest earning
assets.
5. Early Accumulation: (Age 30-40): Diversification in stocks, bonds,

mutual funds, post office deposits, company deposits, real estate, gold,
derivatives begins.
6. Rapid Accumulation (Age 40-54): Major focus is on managing risk

and optimize tax efficiency. and trying out exotic and foreign
investments.
7. Financial Independence or retirement: (Age 55-69): Strategic

priorities change from accumulating wealth to conserving wealth,
! !16
revising health insurance and creating safe cash flows for sustaining
living expenses.
8. Golden years after retirement: (Age 70-84): Main focus is on

consolidation with lower risk and estate planning.
9. Distribution: (Age 85+): Investment for creating in memories by

gifting money to children or temple or charities.
10.Sunset years i.e. less than 12 months to live: Ensuring distribution

of wealth for smooth succession planning and reduction of estate taxes.
The goal of a rational investor is to identify the efficient portfolios and

focus on the optimal portfolio suiting his risk appetite. An efficient portfolio
has the highest return and has the lowest Risk.
Once an optimal portfolio has been constructed, it becomes necessary for

the investor to constantly monitor the portfolio to ensure that it does not
lose it optimality. This process is called portfolio revision. The investor may
have to revise his portfolio by addition (purchase) of some new securities
and deletion (sale) of some of the existing securities from the portfolio.
Portfolio evaluation in terms of return and risk needs to be do done on a
periodic basis.
The portfolio management process is an ongoing process. It starts

with security analysis, proceeds to portfolio construction, continues with
portfolio revision and ends with portfolio evaluation.
The whole process of portfolio management has become quite easy with
the introduction of computers in portfolio management. Moreover,
simulation, modelling etc. provide means of testing alternative solutions.
Liberalization and Globalization of the economy has promoted free flow of

capital across international borders. Portfolios now include not only
domestic securities but also foreign securities.
! !17
1.10 Activities for students
Activity 1. Based on your life cycle stage, and your income and risk
appetite, write your investment policy specifying the investment options
chosen and its role in achieving your financial goals.
____________________________________________________________
____________________________________________________________
____________________________________________________________
1.11 Summary
Savings means the money that remains after satisfying the immediate
consumption requirements. Investment means the utilization of the money
that is saved. Investment in broader terms means putting the money
saved in income or growth asset in order to generate returns for fulfilling
financial goals.
appetite to achieve life’s major financial goals. The basic purpose of
defining investment objectives is to identify the path needed by the
investor to convert a dream into reality. The nature of investment is based
on the investment objective of the investor.
A diverse portfolio can certainly help to protect the wealth from market
volatility and uncertainty. Investors has various choices for investments to
choose from for accomplishing investment objectives such as: Fixed
Income Investment, Equity Investment, Bank deposits, Post Office
Investment schemes, Company fixed deposits, Nidhis and Chit Funds,
Collective investment schemes, Exotic investments, Modern investment
alternatives, Investment in foreign markets and Alternative forms of
Investments.
Investments are based on investors approach to investing to suit lifestyle

needs and investment goals. Investments can be affected by various
factors such as nature of the investment asset class(internal factors),
external factors such as taxation, market volatility etc and even the
investors behavior.
! !18
Investment is an activity, which upon complete analysis assures the safety.

High-risk trades are associated with speculation. A gambler wants to make
quick money and enjoys thrill and excitement without worrying about the
consequences.
Investing can cause various risk right from its origination till expiry such
as Credit risk, Market risk, Liquidity risk, Operational risk, Legal risk,
Regulatory risk, Reputation risk, Settlement Risk, Strategic Risk, Systemic
Risk, and Technology risk.
Allocation of investment between risky and relatively less risky asset

classes makes it smoother for the investor to fulfill his financial goals.
Portfolio management comprises all the processes involved in the creation

and maintenance of an investment portfolio. It deals specifically with
security analysis, portfolio analysis, portfolio selection, portfolio revision
and portfolio evaluation.
! !19
1. Investing can be both rewarding and enjoyable experience if the

investor adheres to the cardinal principles of investment management.
2. What is the difference between savings and Investing
3. Savings is simple but not easy. A wise investor should work on which
savings equation?
4. What is Modigliani’s Life Cycle Theory?
5. Investment financial goals can be achieved by optimizing which

investment objectives?
6. What is the nature of investment for any wise investor?
7. Explain the various choices for investments to choose from for

accomplishing investment objectives?
8. Explain the various factors affecting investments.
9. Explain the difference between Investment, Speculation and Gambling
10.Expalin the various risks faced by an investor while investing.
11.Explain the various allocation strategies adopted by a wise investor to

manage risk in investing.
12.Explain the various stages of Portfolio Management.
13.Explain the Stages of financial Life Cycle
! !20
Multiple Choice Questions
1. Investments can be differentiated from each other based on the aim of

the money spent. A diverse portfolio can certainly help to protect the
wealth from market volatility and uncertainty. Which of the following
type of investment fetches fixed and periodic returns?
a. Fixed Income Investment
b. Equity or Equity related Investment
c. Exotic investments
d. Derivatives investments
2. Income levels and expenditure pattern of the individuals greatly decide

their size of investment. It also enables an investor to plan his needs,
prioritize them according to importance, essentiality and time frame.
Which of the following are major factors which can affect investments?
a. Market Volatility
b. Regulatory Changes and fiscal policies
c. Social Dynamics
d. All of the above
3. Before making any investment decision an investor should be first

equipped with information on various investment options, must have
ready access to various avenues of investment and then make
investment decisions based on proper analysis and evaluation of
information. State whether the above statement is True or False
a. True
b. False
4. Just like the difference between saving and investment, the financial
world is ingrained with yet another financial jargon in the form of
investment and speculation. The main difference between speculating
and investing is:
a. Amount of money invested
b. Risk taken
c. Liquidity available
d. All of the above
! !21
5. An investment is made to accomplish an objective for an investor.

appetite. Which of the following can be an investment objective of a
investor belonging to the 30-40 age group?
a. Estate planning
b. Start saving for building wealth
c. Early Accumulation
d. Conserving wealth
6. The return and risk of each portfolio has to be computed mathematically

and expressed quantitatively along with pair-wise correlations among
them. Which of the following security carries minimal risk?
a. Bank deposits
b. Government bonds
c. Mutual Funds
d. Investments in Derivatives
7. Asset allocation strategy helps timely achievement of financial goals.

Which of the following asset allocation strategy is based on investor’s
risk tolerance and the asset allocation is changed based on expectations
about capital market conditions?
a. Strategic Asset Allocation
b. Tactical Asset Allocation
c. Integrated Asset Allocation
d. Algorithmic Asset Allocation
Ans: 1 - (a), 2 - (d), 3 - (a), 4 - (b), 5 - (c), 6 - (b), 7 - (b)
! !22
1.13 References
1. Investment Analysis and Portfolio Management by Prasanna Chandra
2. Analysis of Investments and Management of Portfolios by Frank Reilly

and Keith Brown
3. Investment Management by Bhalla V.K.
4. Investment Management by Dr.L.Natarajan
5. Investment Management by Maheshwari and Yogesh
6. Security Analysis and Portfolio Management by Sudhir Gupta
! !23
REFERENCE MATERIAL
Click on the links below to view additional reference material for this
chapter
Summary
PPT
MCQ
Video Lecture - Part 1
Video Lecture - Part 2 
! !24
INVESTING IN DEBT INSTRUMENTS
Chapter 2
Investing in Debt Instruments
Objectives:
This chapter will help you understand various options for investing in the
debt market. It will also help you understand the importance of investing in
debt instruments.
Structure:
2.1 Introduction
2.2 What is a Debt?
2.3 Government Securities Market
2.4 Corporate Bond Market
2.5 Risks Associated with Debt Securities
2.6 Valuation of Debt Instruments
2.7 Taxation on Debt Securities
2.8 Summary
2.10 References
! !25
2.1 Introduction
Debt market is known by different names such as fixed income market,

fixed maturity market, bond market or even the credit market. Debt
market is a market for the issuance, trading and settlement in debt
instruments such as bonds, treasury bills, cash management bills,
securitized debt instruments, certificate of deposits, commercial papers
etc. In fact the bond market is much larger than the stock market and
more important from a economic point of view. The size of the world bonds
market is nearly equivalent to the total GDP of all the countries of the
world. India’s debt market is nearly equal to 30% of its GDP. The
Government securities market takes a larger share in terms of turnover in
debt market.In a primary debt market long term debt securities are issued
by companies, corporations, municipal bodies, local authorities etc. The
Government securities market is the largest segment of long term debt
market in India and is followed by public sector undertakings and private
corporate sector.. Corporate bonds are issued by Financial institutions,
banks, public sector companies etc. Debt securities are listed and traded
on the exchanges in a secondary market. Debt instrument can be bought
and sold in call money, notice money, term money markets for overnight
and short term borrowing with maturity period of one or less than one
year. For e.g. call (overnight), short notice (upto 14 days), term money
(15days upto less than one year). The call money, notice money, term
money markets are also called money markets. These liquid and vibrant
money markets facilitate the development of long term securities market
by increasing the liquidities of securities. Long term debt instruments such
as bonds and debentures are issued in capital market.
Though the market for debt instrument is traditionally whole sale in nature,
the financial sector reforms have enabled retail investments also in debt
market. With a view to encouraging wider participation of all classes of
investors, including retail, across the country in government securities, the
Government, the Reserve Bank of India (RBI), and the Securities and
Exchange Board of India (SEBI) has introduced trading in government
securities through a nation wide, anonymous, order driven, screen based
trading system of the stock exchanges
! !26
The borrowers use the money for buying assets, grow its business or for
any productive purpose. Issuer of the debt security borrows money from
lender(investor). Debt security holders, who hold the debt instrument till
maturity receive principal and interest (also known as coupon) according to
a pre-determined schedule. Participants who buy and sell debt securities
before maturity are exposed to many risks but aim at booking profit yields.
Debt markets determine the price in terms of yield that a borrower must
pay in order to receive funding. Debt instruments with floating rate
coupons offer floating rate that is calculated shortly before the next
payment. Zero-coupon bonds do not pay interest but are issued at a deep
discount to account for the implied interest. A debt market index measures
the performance of debt securities. National Stock Exchange(NSE)
computes indices for government securities and corporate bonds of
different credit rating categories. The S&P BSE India Bond Index is
designed to track the performance of local-currency denominated
government and corporate bonds from India. The Reserve Bank of India
(RBI) regulates the Government securities market and money market,
while the corporate debt market is regulated by Securities and Exchange
Board of India (SEBI).
2.2 What is a Debt?
Debt is a Long-term source of fund for a corporate enterprise. A debt

instrument is a paper or electronic obligation that enables the issuing party
to raise funds by promising to repay a lender in accordance with terms of a
contract. It also offers possibility of trading the instruments in the debt
market and thus enables investors to gain from debt instruments in short
term too.
Individuals, businesses and governments use various types of debt

instruments, such as loans, bonds and debentures, to raise capital or
generate investment income.
Loans enable the borrower to borrow a certain sum from the lender in
exchange for repayment over a specified period of time. The borrower has
to pay interest which can be a fixed or floating rate based on mutual
agreement.
! !27
Bonds are similar to loan instruments, but instead of borrowing money

from a bank or single lending source, a company instead borrows money
from the public. Bondholders are entitled to priority in repayment of their
investments from the company's assets if the investment is backed by the
assets.
Debentures are issued to raise short-term capital to fund specific projects.

Debentures are backed only by the credit and general trustworthiness of
the issuer, if the investment is not backed by assets
Different Terminology for Debt Instrument
Germany: debt instruments are known as bunds
France: Government debt instruments are called Obligations Assimilable

de Tresor
UK: Government debt instruments are called Gilt Edged Securities
Italy: Government Debt instruments are called Buoni del Tescoro

Poliennali
US: Government Debt instruments are called Treasury Notes
India: Government debt instruments are called Treasury Bills
The debt is one of the most vital components in the financial system. The
debt market is the market where debt instruments of various types and
features especially of fixed income nature are issued and traded. An
efficient debt market provide a competitive market structure, low
transaction cost, high level of heterogeneity of market participants and a
strong and safe market infrastructure. It also reduces the borrowing cost of
the Government and provides greater funding avenues-thereby reducing
pressure on institutional financing.
The debt market plays a key role in the efficient mobilization and allocation
of resources in the economy, implementing and tuning to the monetary
policy requirements, facilitates both short term and long term liquidity
management and creates a price discovery mechanism for government and
non-government securities in financial markets.
! !28
Most primary debt instruments are privately placed or auctioned to

participants. Secondary market dealings are done through phone.
The turnover in Indian debt market was quite low till the early 1990s.The
debt market was underdeveloped due to administered interest rates and
availability of other avenues for earning higher interest rates. However, the
financial sector reforms in the early 1990s brought in huge transformation
in the debt market and invented a vibrant, efficient and market to fulfill
huge demands for investment and development of infrastructure projects.
Debt instruments can be issued by the Government (both Central and

State), Public Sector Undertakings as well as the Private Corporate Sector.
2.3 Government Securities Market
The Government securities are included in the definition of securities in the

Securities Contracts (Regulation) Act, 1956 (SCRA) and mean a security
created and issued by the Central Government or a State Government for
the purpose of raising a public loan in a form specified in the Public Debt
Act 1944.
The Government securities (G-secs)market facilitates borrowings by the

Government. Based on its annual budget of anticipated sources of
revenues and expenditures the Government borrows money by issuing
securities for in order to meet the shortfall in expenditure. The Government
securities consist of both the Central and State Government securities.
RBI acts as the debt manager for the Centre and the States. As a debt
manager, RBI is not only the issuer but also procedurally maintains a
record of ownership and the transactions that take place in Government
securities. RBI is also the regulator of the market for Government
securities. The issue of G-secs is regulated by RBI under the Government
Securities Act,2006.
G-secs are issued through a auction mechanism by RBI through a French

auction (variable price auction) or a Dutch auction (uniform price auction).
In a French auction successful bidders pay the actual bid price, while in a
Dutch auction, successful bidders pay a uniform cut off price.
! !29
Government securities are issued through auctions conducted by the

Reserve Bank of India (RBI).Bidding in the auction is done through
competitive bidding and non-competitive bidding. Non – competitive bids
are received from a small portion of investors at a weighted average price
of all successive bids. Non-competitive bidding was introduced for
facilitation of retail investor participation in government securities and T-
Bills. It enables medium and small investors to participate in the auction
process without taking the price risk in auctions. A retail investor would be
thus able to participate in the auctions of dated government securities
without having to quote the yield or price in the bid. Retail investors can
approach primary dealers or their custodian banks with whom they have
demat account to trade in government securities. RBI has issued guidelines
allowing access to NDS-OM (Negotiating Dealing System – Order Matching)
platform to retail investors to buy government securities.
There are three ways to trade directly:
1. NDS-OM Web: The retail investor can approach his DP Bank to give
access to this module to trade directly on NDS OM
2. NDS-OM Main: here the retail investor cannot trade directly but can
place orders through their DP bank for the desired price/quantity/
security.
3. Bilateral trades in Voice Market: The NDS OM also has a module

called Reported Deal Segment for trades which are concluded outside
the electronic platform. A retail investor can buy/sell with a preferred
known market participant, report the trade to his DP Bank who would be
a member with NDS-OM and settle the trade on NDS-OM.
RBI is providing an electronic platform called Negotiated Dealing System

(NDS) to provide online price information of transactions in government
securities and for facilitating negotiated dealing in government securities.
The NDS also provides an interface to the Securities Settlement System
(SSS) of the Public Debt Office of the RBI to facilitate settlement of
transactions in government securities. All outright trades in government
securities done or reported on the NDS have the facility of guaranteed
settlement extended by the Clearing Corporation of India Ltd (CCIL)
through the process of novation. Market participants are required to
maintain Subsidiary General Ledger (SGL) accounts or current account and
! !30
be members of INFINET, a closed user group network which serves as a

communication backbone.
The Government securities are deemed to be listed at issuance under the

bye laws of the NSE and BSE. In order to disseminate information to the
market about the securities that are eligible to be traded on the exchanges,
the RBI would immediately after the closure of an issue, inform the
permitted exchanges and the depositories, the amount, tenure, coupon,
and such other particulars. The list of securities which would be traded on
the permitted exchanges can be seen from RBI website.
NSE and BSE also provide a Wholesale Debt Market (WDM) segment to
facilitate trading and settlement. The settlement of these deals is done
directly between the counter parties on a trade for trade basis without
netting and also without the involvement of the stock exchange and its
settlement guarantee fund.
The primary debt issues are privately placed or auctioned to the

participants while secondary market dealings are negotiated over the
telephone.
The participation in secondary market in government securities is restricted

to banks, financial institutions, mutual funds, Foreign Institutional
Investors (FIIs) Trusts etc. The trades were done through negotiations,
with the knowledge of counter parties and usually over the phone rather
than the trades being matched on an anonymous automated price time
priority mechanism.
The Government, the RBI and the SEBI has allowed trading in government
securities through the anonymous order driven screen based trading
system of the stock exchanges which will facilitate participation by all
classes of investors and increase market access across the country. This
facility of trading of government securities on the stock exchanges would
be in addition to the present NDS of the RBI which will continue to remain
in place. The Retail Debt Market, presents opportunities for the Indian
investor whose knowledge and participation hitherto has been restricted to
the equity market.
! !31
The aggregate turnover (in central and state government dated securities
and T-bills) through the SGL (including outright and repo transaction) and
through WDM has grown multi-fold times.
G-sec Reported on NDS-RST Platform As on 09 Nov 2018
G-sec Reported on NDS-RST Platform All Prices in Rs.

Security Security Coupon Maturity LTP Yield Weighted Turnover
Average
Code Descript % Date (Rs.
ion Price Lakhs)
364TB20 364 0.00 20 Sep 94.0700 7.33 94.07 1,35,000.00

92019 DAYS   2019
T-BILLS
817GO1 8.17% 8.17 01 Dec 100.7500 8.13 100.75 19,000.00

2044 GOI 2044
2044
717GOIJ 7.17 % 7.17 08 Jan 96.0500 7.35 96.05 12,500.00
AN28 GOI 2028
BOND
2028
857GOI2 7.59% 7.59 11 Jan 99.0900 7.63 99.09 5,000.00

026 GOI 2026
2026
737GOU 7.37 GOI 7.37 16 Apr 99.0500 7.45 99.05 5,000.00
APR23 BOND 2023
2023
Total 184000.00
Source: https://www.bseindia.com
! !32
Retail Trading in Corporate Debt As on 09 Nov 2018|04:00 PM
Group No, of No. of No. of Volume Turnover

Securities Securities Securities Traded (No. (Rs. Cr.)
Listed Available Traded of Shares)
for
Trading
F 11707 9201 140 58,599 1,155.09
FC 42 38 0 0 0.00
Total 11749 9239 140 58,599 1,155.09
Retail Debt Segment in Government Bonds As on 09 Nov 2018|

04:00 PM
!
! !33
BSE’s "Debt Market Analytics" is an in-depth research report aims at

expanding the horizon of the knowledge on the money market instruments,
government securities and corporate bonds. With daily update on the
Indian Debt Markets, BSE aims at strengthening the knowledge in debt
markets in India.
! !34
Debt Market Analytics broadly divided in to three parts:
Corporate Bonds Transactions
Gives information on corporate bond transactions reported on BSE, NSE &

FIMMDA platform
Debt Market Report
This report includes information on Money market products (rates & trading
volume of call market, repo market & CBLO market), Government
Securities (spread between various maturities, trading volumes, traded
yields) & corporate bonds (rating & tenure vise yield information).
New issue information
Information on new corporate bond issuance with detailed information viz:

issue size, issue opening, issue closing date etc.
Participants in the Government Securities Market
The participants in the Government Securities Market is a small number of

large players and hence it has evolved as a Whole Sale Market.
The Major Participants in Debt Market are as Follows
1. Central Government: Raises money through the issue of dated

securities and treasury bills to finance the budget deficit and other
short-term and long-term financial requirements.
2. State Government, Municipalities and Local bodies: Issues

securities to finance budget deficit and development projects.
3. Reserve Bank of India: Acts as Investment banker to the Government

to raise funds, issue securities, participate in open market operations,
regulate rates, publish monetary policy which can directly impact all
participants.
4. Primary Dealers: are Market intermediary authorized by RBI to deal in

Government securities. They underwrite and make market in
! !35
Government securities. Primary dealers(PDs) are registered entities with

the RBI who have the license to purchase and sell government securities
5. Public Sector Undertakings (PSU’s): Issue Tax free and Taxable

bonds to meet long term and working capital needs. They also invest in
bonds issued in debt securities to park their surplus funds.
6. Corporate Treasuries: issue short and long term securities to meet

their long term and working capital requirements also invest in debt
markets.
7. Banks: are largest investors in debt market due to their statutory

requirement of holding certain percentage of net demand and time
liabilities in Government securities (statutory liquidity requirement) as
per RBI guidelines. Banks also issues Certificate of Deposits and bonds
in debt market. They are also active in inter-bank call notice money
term and repo market to meet short term funding requirements.
Banks normally invest 10% to 15% more than the normal requirement in
Government Securities because of the following requirements:-
a. Risk Free nature of the Government Securities
b. Greater returns in G-Secs as compared to other investments of

comparable nature
8. Insurance companies: are largest buyer of debt securities with longer

maturities. IRDA specifies the limits of investment in debt market.
9. Mutual Funds: are active participants and traders in debt funds due to
growing number of debt funds such as money market mutual funds,
liquid and ultra liquid funds and gilt funds. Mutual funds are not
permitted by SEBI to borrow funds except for very short term liquidity
requirements.
10.Provident funds and Pension funds: are permitted by PFRDA to

invest in dated Government securities and Treasury bills within certain
specified limits.
! !36
11.Charitable institutions and Trusts: are permitted to invest in debt

funds as per their bye laws. They are also large investor of funds but
the type of bonds to be invested and the manner of trading is prescribed
by the bye laws.
12.Foreign Institutional Investors: have been permitted by the

Government to invest in Government securities and Corporate bonds
within certain specified limits.
The Following Investor Segments Participate in the Retail Debt

Market
• Mutual Funds
• Provident Funds
• Pension Funds
• Private Trusts.
• Religious Trusts and charitable organizations having large investible
corpus
• State Level and District Level Co-operative Banks
• Housing Finance Companies
• NBFCs and RNBCs
• Corporate Treasuries
• Hindu-Undivided Families (HUFs)
• Individual Investors
Major Instruments in Government Securities Market
Primary Market
Government bonds are issued in a sale by tender or by auction. In dealers

market, the dealer announces a price at which a debt instrument would be
bought/sold. It is also called quote driven market. In order driven market,
trade takes place when dealers can match orders to buy and sell.
Government securities (G-secs) account for 70 - 75% of the outstanding

value of issued securities and 90-95% of the trading volumes in the Indian
Debt Market. State Government securities & Treasury Bills account for
around 3-4 % of the daily trading volumes. G-secs in India generally have
a face value of Rs.100/- bearing semi-annual coupon or interest payments
with a tenor of between 5 to 30 years. The minimum order size shall be 10
! !37
units of G-secs with a face value Rs.100/- each equivalent to an order

value of Rs.1000/- and the subsequent orders will be in lots of 10
securities each. T-Bills are instead issued at a discount to the face value
(say @ Rs.95) and redeemed at par (Rs.100). The difference of Rs. 5 (100
- 95) represents the return to the investor obtained at the end of the
maturity period.
There are normally two types of transactions, which are executed in the
Wholesale Debt Market:
a. An outright sale or purchase and
b. A Repo trade
After Debt instruments are issued to investors, they are traded in the
secondary markets
G-Secs can be Held in Either of the Following Forms
a. Physical Security (which is mostly outdated & not used much)
b. SGL (Subsidiary General Ledger) A/c with the Public Debt Office of
the RBI. The SGL A/cs are however restricted only to few entities like
the Banks & Institutions.
c. Constituent SGL A/c with Banks or PDs who hold the G-secs on behalf
of the investors in their SGL-II A/cs of RBI, meant only for client
holdings.
d. Demat A/c as is used for equities at the Depositories. NSDL & CDSL
will hold them in their SGL-II A/cs of RBI, meant only for client
holdings.
! !38
Secondary Market
G-secs are deemed to be listed after issuance and hence are eligible for
trading in secondary market such as NSE and BSE.
Trades in secondary market are settled through a system of delivery versus

payment which involves simultaneous transfer of security by seller and
payment by buyer.
The settlement function is performed by CCIL. The settlement cycle for

government securities is T+1.
Retail investor can buy G-secs from a primary dealer or a commercial bank
in demat form.
FIMMDA-NSE MIBID MIBOR
FIMMDA-NSE MIBID MIBOR is a reference rate is an accurate measure of

the market price. In the fixed income market, it is an interest rate that the
market respects and closely watches. It plays a useful role in a variety of
situations.
The MIBID/MIBOR rate is used as a bench mark rate for majority of deals
struck for Interest Rate Swaps, Forward Rate Agreements, Floating Rate
Debentures and Term Deposits.
For e.g. a call money reference rate can be structured as offsets from the
future levels of a reference rate.
NIFTY Fixed Income indices offer independent and comprehensive

benchmarks for the fixed income market in India and cover government
securities also.
! !39
G-sec Indices
An index is important to measure the performance of investments against

a relevant market index.The G-sec indices are useful tool for investors to
measure and compare performance of G-secs
NSE computes indices for G-secs
NIFTY G-Sec Indices represent Government of India bonds across 6 distinct

duration buckets.
List of NIFTY G-Sec Indices
• NIFTY Ultra Short Duration G-Sec Index

• NIFTY Low Duration G-Sec Index
• NIFTY Short Duration G-Sec Index
• NIFTY Medium Duration G-Sec Index
• NIFTY Medium to Long Duration G-Sec Index
• NIFTY Long Duration G-Sec Index
The indices have a base date of 03rd September, 2001 and a base value of
1000
The Index seeks to measure the performance of most liquid Government of

India bonds across 6 distinct duration buckets
Based on a well-defined, market relevant and rules-based framework, the

indices are transparent and objective indicator of corporate bond market
performance
The indices are rebalanced and reconstituted on monthly basis
! !40
! !41
Types of Securities
1. Treasury Bills: Treasury bills (T-bills) are money market instruments,

i.e., short-term debt instruments issued by the Government of India,
and are issued in three tenors—91 days, 182 days, and 364 days. The
T-bills are zero coupon securities and pay no interest. They are issued at
a discount and are redeemed at face value on maturity.
2. Cash Management Bills: Cash management bills (CMBs) have the

generic characteristics of T-bills but are issued for a maturity period less
than 91 days.
3. Dated Government Securities: Dated government securities are long-

term securities that carry a fixed or floating coupon (interest rate),
which is paid on the face value, payable at fixed time periods (usually
half-yearly). The tenor of dated securities can be up to 30 years.
4. State Development Loans: State governments also raise loans from

the market and are issued as dated securities through an auction similar
to the auctions conducted for the dated securities issued by the central
government.
5. Fixed Rate Bonds: These are bonds on which the coupon rate is fixed
for the entire life of the bond. Most government bonds are issued as
fixed rate bonds.
6. Floating Rate Bonds: Floating rate bonds are securities that do not
have a fixed coupon rate. The coupon is re-set at pre-announced
intervals by adding a spread over a base rate. The base rate of floating
rate bonds issued by Government is the weighted average cut-off yield
of the last three 364-day. In treasury bills auction, spread is decided
through the auction Floating rate bonds were first issued in India in
September 1995.
7. Zero Coupon Bonds: Zero coupon bonds are bonds with no coupon
payments. Like T-Bills, they are issued at a discount to the face value.
The Government of India issued such securities in the 90s; it has not
issued zero coupon bonds after that.
! !42
8. Capital Indexed Bonds: Capital Indexed Bonds principal is linked

to an accepted index of inflation with a view to protecting the holder
from inflation. Capital indexed bonds, with the principal hedged against
inflation, were first issued in December 1997.
9. Bonds with Call/Put Options: Bonds with Call/Put Options Bonds are
issued with features of optionality, wherein the issuer can have the
option to buy back (call option) or the investor can have the option to
sell the bond (put option) to the issuer during the currency of the bond.
10.Sovereign Gold bonds: Sovereign Gold Bonds are Government

securities denominated in multiples of gram(s) of gold. They are
substitute for investment in physical gold.. These Bonds are issued by
the Reserve Bank of India on behalf of the Government of India and are
traded on stock exchange. The bond bears an interest at the rate of
2.50% (fixed rate) per annum on the nominal value. Bond carry
sovereign guarantee both on redemption amount and on the interest
11.Tax free bonds: interest earned from tax-free bonds is exempt from
tax. Public sector undertakings such as IRFC, PFC, NHAI, HUDCO, REC,
NTPC have raised funds through the issue of tax-free bonds. The bonds
are tax-free, secured, redeemable and non-convertible in nature.
Advantages of investing in Government Securities (G-Secs)
• Zero Default Risk
• Greater safety and lower volatility
• Variations possible in the structure of instruments like Index linked

Bonds, STRIPS
• Higher leverage available in case of borrowings against G-Secs
• No TDS on interest payments
• Tax exemption for interest earned on G-Secs
• Greater diversification opportunities
! !43
• Adequate trading opportunities with continuing volatility expected in

interest rates the world over
• The returns earned on the government securities are normally taken as

the benchmark rates of returns and are referred to as the risk free return
• The Risk Free rate obtained from the G-sec rates are often used to price
the other non-govt. securities in the financial markets
2.4 Corporate Bond Market
Corporate debt instruments are differentiated by claim on the assets of the

company. The corporate debt market is also known as the non-Gsec
market.
Primary Market
Corporate bonds can be issued both publicly and privately. However over
90% of the corporate bonds are privately placed as cost of raising is very
less comparing to the cost of raising from the market. Corporates are
required to report details of resources raised through private placements to
the stock exchanges. Private placement of bonds is mostly done through
book building way. The cutoff yield is decided by the issuer and the book
runner based on the letters of commitment received from investors.
The public issue of corporate bonds is done on a fixed price basis through a
offer document as per SEBI guidelines( SEBI (Issue and Listing of Debt
Securities) Regulations, 2008).
Secondary Market
Corporate bonds once issued can be listed on the exchanges that trade
equity. A larger chunk of trading happens in the over-the-counter(OTC)
market.
! !44
Major Points to be Checked from a Bond Issue

1. Issuer name
2. Issuer type
3. Coupon rate
4. Maturity
5. Issue currency
6. Credit rating
7. Yield to maturity
8. Price
9. Issue size
10. Denomination
Types of Bonds
1. Coupon Paying or Discounted Bonds
• Annual coupon paying bonds provide a fixed sum of coupon every year.
• Cumulative coupon paying bonds do not pay periodical coupon but on

maturity the bond holder gets the entire amount invested along with the
coupon earned during the fixed tenure.
• Floating rate coupon paying bonds pay coupon not on a fixed rate but
on a reference rate which is reset periodically. The reference rate can be
MIBID, MIBOR or even LIBOR.
• Zero coupon bonds don’t pay any coupon. The bond holder buys the
bond at a lower price and gets the par value on maturity. The difference
between the issue price and the par value is the gain on investment.
• Deep Discount bonds are issued at a discount to their redemption

value at the time of maturity. Deep discount bonds have longer maturity,
no interest, low initial payment and high face value
2. Convertible Bonds or Debentures
• Vanila convertible bonds have predetermined conversion ratio.

Traditional bonds that are issued with an interest rate are called straight
bonds or plain vanilla bonds or bullet bonds.
! !45
• Exchangeable bonds allows conversion into equity other than issuer
• Perpetual bonds don’t have a pre specified maturity date ad offer a

higher rate of interest. The company has the option to call them at the
end of certain time period.
Different Types of Corporate Debt Securities issued as Debentures

are as Follows
• Non-Convertible Debentures
• Partly-Convertible Debentures/Fully-Convertible Debentures (convertible

in to Equity Shares)
• Debt instruments that are not secured are called unsecured bonds.
• Debt instruments guaranteed by third party are called termed

guaranteed bonds.
• Debt instruments that have an option of being converted into other types
of financial instruments are called convertibles.
• Debt instruments with options are called callable bonds or puttable bonds
• Debt instruments which can update par value periodically in line with a
price index and the coupon payment increased or decreased by the
amount of change in the index are called index-linked bonds.
• Euro bonds are issued in currency that is not the currency of the country
of issue.
! !46
Commercial Papers (CPs) are issued by corporates, primary dealers and

all India financial institutions as a source of short term finance.
Certificate of Deposits (CDs) are issued by Banks and select all India
financial institutions as a source to meet short term funding needs.
Advantages of Investing in Corporate Bond Market
• Reduces cost of capital for corporates
• Investors have a wider choices to create a good portfolio for investing
• Bonds pay interest at a set rate
• Investing in debt securities generally has less risk
• Maximum priority in payment during liquidation
• Increases investors confidence as they are backed by security
• High liquidity
• The payments of a corporate bond are structured
• Some corporate bonds may be converted into stocks
• SEBI has cut the timeline for listing of debt securities to six days in order
to make the existing process of issuance of such securities simpler and
cost effective
• Issuer has to create a debenture redemption reserve for redemption of

bonds through public offer
• Credit ratings can speak about the credit quality of an individual debt
issue
! !47
2.5 Risks associated with debt securities
Investments in debt securities typically involve less risk than equity

investments. However they are also subject to certain systemic and
unsystemic risk.
Default Risk (Credit risk): Risk that an issuer of a debt instrument may
be unable to make timely payment of interest or principal on a debt
security or to otherwise comply with the provisions of a bond indenture.
Interest Rate Risk: Risk emerging from an adverse change in the interest
rate prevalent in the market so as to affect the yield on the existing
instruments.
Reinvestment Rate Risk: Possibility of a fall in the interest rate resulting

in a lack of options to invest the interest received at regular intervals at
higher rates at comparable rates in the market.
Counter Party Risk: Risk associated with any transaction and refers to
the failure or inability of the opposite party to the contract to deliver either
the promised security or the sale-value at the time of settlement.
Price Risk: Possibility of not being able to receive the expected price on
any order due to a adverse movement in the prices.
! !48
2.6 Valuation of Debt Instruments
The Price of a Debt Instrument is determined by the forces of demand

and supply. The price of a debt instrument depends on a number of other
factors such as:
• Economic conditions
• General money market conditions including the state of money supply in
the economy
• Interest rates prevalent in the market and the rates of new issues
• Future Interest Rate Expectations
• Credit quality of the issuer
Yields and Debt instrument prices are inversely related. A rise in price will
decrease the yield and a fall in the debt instrument price will increase the
yield.
When the prevailing interest rates in the market rise, the prices of
outstanding bonds will fall to equate the yield of older bonds into line with
higher-interest new issues. When the prevailing interest rates in the
market fall, there is an opposite effect.
G-Secs are traded on a clean price (Trade price) but settled on the dirty
price (Trade price + Accrued Interest). The Cumulative face Value of the
securities in a transaction is the face Value of the Transaction and is
normally the identifiable feature of each transaction.
The government abolished stamp duty on debt securities to boost the

dematerialisation of debt securities and enhance levels of trading in
corporate debt securities.
The cost besides the price of the security includes the charge by
the seller as a commission. The price of a security will have a bid price
and offer price.Bid price is the dealers buying price and offer price is the
dealers selling price. The difference between a bid and offer price is called
spread.
! !49
Present Value of all future cash flows from the instrument discounted at an
expected rate of return can be calculated with the following formula:
PV = FV/(1+r)n
Where,
PV = Present Value
FV = Future Value
r = Discount rate
n = Time at which the future value is expected to occur
Example: Expected Cash flow Rs.10000 at end of 6 years, Discount rate

7% pa
Solution: PV = 10000/(1+0.07)6
= 10000/1.5007
= Rs..6,635.70
When Future Cash flows are not one-time occurrence's ( Annuity)
Present Value of Annuity (PV) is the summation of the discounted Cash

Flows(CF) stream over the time of occurrence.
PV = !
Where,
PV = Present Value of Annuity

CF = Cash Flows
r = Discount rate
n = Time at which the future value is expected to occur
Example: Expected cash flow Rs.10000 at the end of each year for 3
consecutive years; Discount rate 6%
! !50
Solution:
PV = !
= Rs. 26,730
If cash flows occurrences are more frequent
Discount rate is also suitably adjusted to compound the cash flows
PV =!
Yield to Maturity
The Yield to Maturity (YTM) is the rate that equates the current price to
future cash flows from the debt instrument.
Po = IxPVIFA(kd%,years) + FxPVIF(kd%,years)
Example: A bond Rs.1000 face value, Current market price(P) is Rs.

924.20, Coupon rate 8%, maturity 5 years. What is the rate of return if the
bond is hold till maturity?
Solution: We can also use YTM formula (approximation) i.e.
YTM = I + (F-P)/n/0.4 x F + 0.6 x P
YTM = {80+ (1000-924.20) / 5} / 0.4 (1000) + 0.6 (924)

= 80+15.16/ 954
= 0.0997
= 10%
Running Yield
The simple rate of return relating to the periodic coupon payments to the
clean price of the debt instrument is called the Running Yield.
Useful for evaluating bonds with a short holding period
Running Yield = Coupon/Clean Price
! !51
Example: Lot size Rs. 100 bond; Coupon 6% p.a.; Ex-coupon clean price
Rs. 96
Solution: Running Yield = (6/96) x 100 = 6.25%
Simple Yield to Maturity
Simple yield to maturity considers the coupon payment and the capital
gains that are realized from holding the debt instrument over a period of
time. It considers the total returns and is useful when the bond maturity is
nearer. It may not be useful for long term bonds
Formula for computation of simple yield to maturity is as follows:
YTM = (C/F)+(F– P)/nxP)

Where,
C = coupon amount
F = face value of the bond
P = clean price
n = number of years to maturity
Example: 10 year 10 %Bond at Rs.96.65
Solution:
Simple Yield to Maturity = (10/96.65)+(100-96.65)/(10x96.65)

= 0.1035+3.35/966.5
= 0.1035+0.0034
= 0.1069
= 10.69%
! !52
Redemption Yield
The redemption yield is the return that equates the discounted values of
the bond’s cash flows. It considers the coupon payment received over the
life time of the bond for reinvestment. It also considers the capital gain or
loss between purchase and redemption.
Redemption Yield is also called as the internal rate of return for the debt
instrument.
Formula for computation of Redemption Yield is as follows:
Yr = {C+(M-P/n)}/M+P/2
Where
M= market price of the debt instrument
Example:10 year 6% Rs.100 debt instrument; market price Rs. 113.24;

clean price Rs.111.89
Solution: Yr = { 6+(113.24-111.89/10}/113.24+111.89/2
= {6+1.35/10}/225.13/2
= 0.735/112.56
= 0.0065
= 0.65%
Holding Period Yield
Holding Period Return (HPR) refers to the total return earned from an
investment or an investment portfolio over the holding period. The holding
period can be anything such as 1 day, 1 month, 6 months, 1 year, 5 years
and so on.
Holding Period Return considers different re-investment rates and
recognizes holding period which can be different than maturity date
Formula for computing the holding period =
HPR = (End Value – Initial Value)/Initial Value
! !53
Yield to call
Yield to call is calculated for callable bond. A callable bond is a bond where
the issuer has a right (but not the obligation) to call/redeem the bond
before the actual maturity.
The callable price (redemption price) may be different from the face value.
Yield to call is the yield of a bond or note if you were to buy and hold the
security until the call date.
The complete formula to calculate yield to call is:

P = (C / 2) x {(1 – (1 + YTC/2) ^ -2t)/(YTC/2)} + (CP/(1 +
YTC/2) ^ 2t)
P = the current market price
C = the annual coupon payment
CP = the call price
t = the number of years remaining until the call date
YTC = the yield to call
Example: Face value of callable bond Rs. 1000. Semi annual coupon 10%.
Current market price Rs. 1175. Call price Rs. 1100 5 years from now
Solution: Using the formula:
P= (C/2) x {(1 – (1 + YTC/2) ^ -2t)/(YTC/2)} + (CP/(1 + YTC/2) ^ 2t)

 
we get
1,175 = (100/2) x {(1- (1 + YTC/2) ^ -2(5))/(YTC/2)} + (1,100/(1 + YTC/

2) ^ 2(5))
YTC = 7.43%
! !54
Yield Curve
A Yield Curve is a graphic representation of the relationship between the

yield and the maturity of securities at a particular time. It is used to
compare yields of different securities, benchmark rates and discover yield
divergence.
The instruments plotted on the yield curve must have common

characteristics such as same credit risk and same tax treatment.
Ascending Yield Curve
Higher returns with respect to time are shown by ascending yield curves.
Yield rises for longer maturities
Steady, steep increase or a steep increase in the beginning followed by a

slower rate in latter years can also be seen.
A very slow pace in the beginning and increase in the later years is also
possible.
Descending Yield Curve
Reduction in return with respect to time are shown by descending yield

curve.
This shape is often seen when the market expects interest rates to fall.
2.7 Taxation on debt securities
! !55
2.7 Taxation on debt securities
Interest on Securities
Corporate bonds are debt securities issued by private or public

corporations. Interest on corporate bonds is taxable on accrual basis at
applicable income tax slab rates.
Bonds held in demat form and listed, will not have TDS deduction on
income on securities. However the income needs to be added as income
from other sources in the total income for computation of tax. Hence tax
will be paid as per the applicable income tax slab.
Investing in Tax Free Bonds
If an investor invests in tax free bonds then the interest received from tax
free bonds is exempt under Section 10 (15) (iv) (h) of the Income tax Act,
1961.
Capital Gains
The difference between the purchase and sale price of the bond is treated
as capital gains. Capital gains are taxed on redemption of bonds.
The regulations relating to capital gain has been recently amended in

Finance Act 2018. The capital gains will be long term if listed bonds are
held for more than 12 months. The period of holding for computation of
long term capital gains has been made for more than 12 months in respect
of certain assets like shares (equity or preference), units of equity oriented
mutual funds, units of business trust, convertible bonds or debentures,
Government securities and Zero Coupon Bonds, which are listed in a
recognised stock exchange in India (NSE, BSE, MCX and United Stock
Exchange of India).
If these bonds are held for less than 12 months then the capital gains will
be short term.
! !56
Capital Gains Tax Rate
Short term (Bonds/Debentures & Government as per applicable

Securities) income tax slab rates
Long Term Capital Gains (Listed Government Securities 10%

and no Indexation benefit is taken)
Long Term Capital Gains (Listed Government Securities 20%

Indexation benefit is taken)
Long Term Capital Gains (Unlisted Government 20%

Securities and no indexation benefit is allowable)
• Since Indexation benefit is not available for bonds/debentures of any

company & bonds issued by Government. Hence Tax Rate on Long term
capital gains on listed bonds would be 10%. However indexation benefit
is available on Capital Indexed bonds issued by Government and
Sovereign Gold bonds issued by RBI under Sovereign Gold Bonds
Scheme 2015.
The capital gains tax is applicable only on amount of capital gain exceeding
1 lakh.
A well informed investor can thus plan his investment and be clear on how
much tax needs to be paid on the income earned as well as the redemption
amount of debt securities. A wise investor can also make best use of tax
saving and tax free debt instruments to build an optimum portfolio.
! !57
2.8 Summary
Debt market is a market for the issuance, trading and settlement in debt
instruments. Debt security holders, who hold the debt instrument till
maturity receive principal and interest (also known as coupon) according to
a pre-determined schedule. Participants who buy and sell debt securities
before maturity are exposed to many risks but aim at booking profit yields.
A debt market index measures the performance of debt securities.
Debt is a Long-term source of fund for a corporate enterprise. A debt

instrument is a paper or electronic obligation that enables the issuing party
to raise funds by promising to repay a lender in accordance with terms of a
contract. It also offers possibility of trading the instruments in the debt
market and thus enables investors to gain from debt instruments in short
term too. Individuals, businesses and governments use various types of
debt instruments, such as loans, bonds and debentures, to raise capital or
generate investment income.
An efficient debt market provide a competitive market structure, low

transaction cost , high level of heterogeneity of market participants and a
strong and safe market infrastructure. The debt market plays a key role in
the efficient mobilization and allocation of resources in the economy,
implementing and tuning to the monetary policy requirements, facilitates
both short term and long term liquidity management.
The Government securities (G-secs)market facilitates borrowings by the

Government. RBI acts as the debt manager for the Centre and the States.
The Government securities consist of both the Central and State
Government securities. G-secs are issued through a auction mechanism by
RBI.
The participants in the Government Securities Market is a small number of

large players and hence it has evolved as a Whole Sale Market. The
major participants in Debt market are Central Government, State
Government, RBI, primary dealers, Banks, Corporate treasuries, Mutual
funds, Provident funds, Pension funds, Charitable institutions and Trusts
and FIIs.
! !58
The various types of Government securities include Treasury Bills, Cash

management bills, dated government securities, fixed rate bonds, floating
rate bonds, zero coupon bonds, capital indexed bonds, sovereign gold
bonds, tax free bonds.
Corporate debt instruments are differentiated by claim on the assets of the

company. Corporate bonds can be issued both publicly and privately.
However over 90% of the corporate bonds are privately placed as cost of
raising is very less comparing to the cost of raising from the market.
Corporate bonds once issued can be listed on the exchanges that trade
equity.
Investments in debt securities typically involve less risk than equity

unsystemic risk. The price of a debt instrument is determined by the
forces of demand and supply. The price of a debt instrument depends on a
number of factors such as economic conditions, interest rates, credit
quality etc. The Yield to Maturity (YTM) is the rate that equates the current
price to future cash flows from the debt instrument.
A well informed investor can plan his investment and be clear on how
much tax needs to be paid on the income earned as well as the redemption
amount of debt securities. A wise investor can also make best use of tax
saving and tax free debt instruments to build an optimum portfolio.
! !59
2.9 Self assessment questions
1. What is a debt market?
2. What are the various instruments issued in the debt market?
3. Who are the participants in the debt market?
4. “The debt is one of the most vital components in the financial

system”. Explain
5. Explain the Government Securities Market.
6. Who are the participants in the Government Securities Market?
7. Which investor segments participate in the Retail Debt Market?
8. What are the major Instruments in Government Securities Market?
9. Explain the primary market and secondary market of Government

Securities Market.
10. What are the advantages of investing in Government Securities?
11. What is a Corporate Bond Market?
12. Which instruments are issued in a Corporate Bond Market?
13. What are the major points to be checked from a Bond issue?
14. What are the Different types of corporate debt securities issued as
debentures?
15. What are the advantages of investing in Corporate Bond Market?
16. What are the risks associated with debt securities?
17. The price of a debt instrument depends on which factors?
! !60
18. Explain various methods through which the performance of the debt
instrument can be measured.
19. Explain the taxation on debt securities
1. Which of the following participants in Government securities market are

largest investors in debt market due to their statutory requirement of
holding certain percentage of net demand and time liabilities in
Government securities (statutory liquidity requirement) as per RBI
guidelines?
a. Banks
b. Mutual Funds
c. Insurance companies
d. Non banking finance companies
2. Corporate debt instruments are differentiated by claim on the assets of

the company. The corporate debt market is also known as the non-Gsec
market. Which of the following is an advantage of investing in the
corporate bond market?
a. Investors have a wider choices to create a good portfolio for investing
b. Bonds pay interest at a set rate
c. Investing in debt securities generally has less risk
d. All of the above
3. Investments in debt securities typically involve less risk than equity

unsystemic risk. Which of the following risk is faced by an issuer of a
debt instrument by not being able to make timely payment of interest or
principal on a debt security or to otherwise comply with the provisions
of a bond indenture?
a. Price Risk
b. Market risk
c. Credit risk
d. Operational risk
! !61
4. The Holding Period Yield is the return that equates the discounted
values of the bond’s cash flows. It considers the coupon payment
received over the life time of the bond for reinvestment. State whether
the above statement I true or false.
a. True
b. False
5. The regulations relating to capital gain has been recently amended in

Finance Act 2018. The Long Term Capital Gains tax rate (Listed
Government Securities and no Indexation benefit is taken) during
redemption will be:
a. 10%
b. 20%
c. 30%
d. No tax to be paid
Ans: 1 - (a), 2 - (d), 3 - (c), 4 - (b), 5 - (a)
2.10 References
1. Fixed income Securities by Dun and Bradsteet
2. Investment Analysis and Portfolio Management by Prasanna Chandra
3. Fixed Income Markets in India by Joydeep Sen and Abhishek Apte
4. https://nseindia.com
5. https://www.bseindia.com
6. How to save income tax through tax planning by R N Lakhotia and

Subhash Lakhotia
7. In the wonderland of investment by A N Shanbhag and Sandeep

Shanbhag
8. What every Indian should know before investing by Vinod Pottayil
! !62
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !63
INVESTMENT IN BANK DEPOSITS
Chapter 3
Investment in Bank Deposits
Objectives:
This chapter will help you to understand different types of Bank deposits. It
will also help you to understand the National Pension Plan product sold by
the banks.
Structure:
3.1 Introduction
3.2 Regulatory Framework for Banks
3.3 Different Types of Banking Companies Accepting Deposits from the

Customer
3.4 Different Types of Bank Deposits
3.5 What are Demand Deposits?
3.6 What are Term Deposits or Time Deposits?
3.7 National Pension Scheme
3.8 Summary
3.10 References
! !64
3.1 Introduction
Banks are the oldest institutions not only in India but across the world that
accept various types of deposits and use these funds for granting loans.
The business of banking is that of an financial intermediary between a
saver who lends money and the borrower who invests money into his
business. Customers are offered different types of deposit accounts based
on their time or demand liability preferences. The credit risk of lending
money by the saver to the bank and then by the bank to the borrower is
spread amongst a large customer base.
The banking industry has evolved since the ancient times and has made
seamless developments in range of products driven by technology
advancement as well as the structure of banking delivery channels in order
to suit the needs of civilized customers with changing preferences. The
mode of acceptance deposits has changed from physical cast and forms to
electronic transfers and online submission of documents. Banks are no
more selling their own products but making optimum utilization of its
resources for cross selling third party products such as mutual funds,
insurance and depository services. Various new types of banks such as
payment banks and small finance banks have emerged recently to pose a
serious challenge to the existing and established banks by offering more
interest on deposit from customers. Customers have to make a care full
choice about investing with established players at a lower interest rate or
have faith in the new babies and accept the higher interest rates.
The Central Banking Authority i.e Reserve Bank of India is also depositor
friendly and makes every attempt to increase competition between banks
to offer best rates and quality services, the ultimate benefit of which is
reaped by the deserving depositors. RBI has already deregulated the
interest rates on deposit accounts and has given to the Banks to decide
their own rates on deposit accounts. Deposit accounts no more come with
a single flavor as privatization of banks and introduction of high end
corebanking solutions have enabled bankers to offer multiple favors within
a single deposit scheme. A common customer id for individual customer
helps him to track all bank deposits with a bank in a single view.
Customers are incentivized with cash backs and discounts to use their
account balance through electronic means such as UPI, cards and wallets
at merchant terminals for buying all kinds of goods and services.
Government has also cropped in a 80C tax savings fixed deposit scheme to
! !65
encourage customers to pool in their savings towards development activity

of the Government and avail tax benefits.
Even though a customer has multiple option to invest in money in different

asset classes and gone are the days when the customer predominantly
invested only in Bank deposits, a bank deposit account is essential even
today for meeting routine life needs and deposit of income. Banks today
are also an important part of the payment mechanism of the economy and
still viewed as safe and convenient mechanism in public view.
3.2 Regulatory Framework for Banks
The Banking system in India is regulated by the Reserve Bank of

India(RBI) which is considered as the Central Bank in terms of the Reserve
Bank of India Act, 1934 and the Banking Regulation Act, 1949.
The main objectives of the Reserve Bank of India is to regulate the issue of
bank notes and keeping of reserves with a view to securing the monetary
stability in India and generally to operate the currency and credit system of
the country to its advantage. RBI plays an important role in ensuring the
safety and soundness of the banking system and in maintaining the
financial stability and public confidence in the system. One of the best
thing done for depositors by RBI is the establishment of Deposit Insurance
and Credit Guarantee Corporation of India to insure deposits made by the
customer upto Rs.1 lakh per constituent account with scheduled
commercial and cooperative banks.
The Banking Regulation Act, 1949 was enacted to provide a suitable

framework for regulating the banking companies. The Banking Regulation
Act,1949 regulates the entry into banking business by licensing under
Section 22 as well as puts restrictions on shareholding, directorship, voting
rights and other aspects. A Foreign bank is also regulated by the Banking
Regulation Act,1949.
! !66
The Banking Regulation Act, 1949 empowers the Reserve Bank of India to
issue directions for regulating terms and conditions of accepting deposits,
providing loans and advances and other related matters. Reserve Bank of
India is authorized to regulate the interest rates under Section 21 (read
with Section 35A) of the Banking Regulation Act,1949. Currently Reserve
Bank of India has given freedom to Banks to decide the interest rates on
deposits themselves under the liberalization of interest rate regime, the
Banking Regulation Act,1949 does not contain specific provisions for
acceptance of deposits but Section 35A authorizes Reserve Bank of India to
give directions on acceptance on deposits. The Reserve Bank of India
issues directions on acceptance of deposits and interest rates applicable on
deposits from time to time. The directions may either fix the rates or
specify the minimum or maximum rate of interest on savings deposits and
time deposits for various periods and also for special categories of deposits
like Bank employees, Senior citizens, Non Resident Indians etc.
The directions issued by Reserve Bank of India in exercise of powers under

Banking Regulation Act,1949 are binding on the banks.
Section 26 of Banking Regulation Act,1949 mandates every Bank to file a

return every year on their unclaimed deposits and Banks are expected to
cover all deposits not operated for 10 years.
Section 45ZA of the Banking Regulation Act,1949 provides that a customer

can avail nomination facility on deposits with a banking company. The
depositor can nominate one person in the prescribed form as nominee. In
the event of his death the nominee can receive the balance in the deceased
customer account.
Section 45ZC and Section 45 ZE of the Banking Regulation Act,1949 also

provides nomination facility for customers in Safe Custody and Safe
Deposit Lockers facility provided by the Banks.
! !67
3.3 Different types of Banking Companies accepting

deposits from the customer
According to section 5(b) of the Banking Regulation Act, 1949, “banking”

means the accepting, for the purpose of lending or investment, of deposits
of money from the public, repayable on demand or otherwise, and
withdrawable by cheque, draft, order or otherwise.
According to section 5(c) of the Banking Regulation Act, 1949, Banking

company means any company which transacts the business of banking in
India.
Any company which is engaged in the manufacture of goods or carries on

any trade and which accepts deposits of money from the public merely for
the purpose of financing its business as such manufacturer or trader shall
not be deemed to transact the business of banking within the meaning of
this clause.
Every banking company has to use the word bank, banker or banking in its
name to indicate to the public that it has got a licence from Reserve Bank
of India to accept deposits from the public.
Indian Banking Industry consists of a large number of commercial and

cooperative banks, specialized development banks. The entire banking
industry comes under the Apex bank i.e Reserve Bank of India.
! !68
A scheduled bank means a bank included in the second schedule of the

Reserve Bank of India Act, 1934.A commercial bank is promoted to earn
profits from banking business, while a cooperative bank is established for
benefit of members. A scheduled commercial banks comprises of Public
sector banks which includes the State Bank of India and the 19
Nationalized banks (Canara Bank, Bank of Baroda etc) and the India Post
Payment Bank. Government owns 51% ownership in Public Sector Banks.
The Private banks includes the old private sector banks (Karur Vysya Bank,
South India Bank etc) and the newer ones born since 1990’s (Axis Bank,
ICICI Bank, HDFC Bank etc). Foreign Banks are incorporated abroad but
have RBI licence to open branch offices in India e.g. Citi Bank, Standard
! !69
Chartered Bank. The Regional Rural Banks are established to serve rural
people within a district with tri-support from Sponsor Commercial Bank,
Central and State Government.
After the financial sector reforms in the 1990’s entry of new generation
bank have transformed the way deposits are accepted from the public with
the use of high end technology. The technology disruption created by
fintech companies is further supporting the transformation of way of
accepting deposits. Some of the telco companies have also been permitted
by RBI to convert themselves into payment banks to penetrate banking
services in the nook and corner of the country. Likewise the microfinance
institutions have also been permitted to establish small finance banks
which can accept small deposits as well as make small loans and advances.
3.4 Different types of Bank Deposits
We have to once again refer section 5(b) of the Banking Regulation Act,
1949 to understand the meaning of Bank deposits.
According to section 5(b) of the Banking Regulation Act, 1949, “banking”

means the accepting, for the purpose of lending or investment, of deposits
of money from the public, repayable on demand or otherwise, and
withdrawable by cheque, draft, order or otherwise.
Thus Bank deposits are:
• Accepted from the public

• Repayable on demand or
• Repayable otherwise means on maturity
• Withdrawable by cheque, draft, order or otherwise
Here we have to understand what are demand deposits, time or term

deposits that matures after a fix term and the payment system that is used
for accepting and repaying money. Demand deposits are also called as
Demand Liabilities and Term Deposits are also called as Term Liabilities.
Deposit accounts can be opened in the name of one or more individuals.

Joint account can be operated in different mode of operation such as:
! !70
• Jointly
• Either or Survivor
• Former or Survivor
• Later or Survivor
• Any one or Survivor
"Demand Liabilities" and "Time Liabilities" shall have the same meaning as
defined in Section 18 read with Section 56 of the Banking Regulation Act,
1949;
3.5 What are demand deposits?
"Demand Deposit" shall mean a deposit received by the bank which is

withdrawable on demand
Demand deposits are deposits accepted by the Bank from the customers
and repayable as and when required by the customers i.e on demand.
A customer can open a savings bank account or a current deposit account

as a demand deposit.
Now let us look into more details in each of the above types of deposits.
Savings Bank Account
"Saving Deposit" also known as "Saving Account”, "Saving Bank Account",

"Saving Deposit Account” shall mean a form of demand deposit which is
subject to the restrictions as to the number of withdrawals as also the
amount of withdrawals permitted by the bank during any specified period.
Savings bank account are usually opened by Individuals who wish to save a
part of the current income to meet the future needs as well as to earn
interest on the amount that remains as a balance in the account.
As the customer is allowed to withdraw any time, bank pays lesser interest
on savings bank account in comparison to term deposit accounts.
Interest is calculated on a daily balance basis and paid half yearly in the
month of September and March. Some banks also pay quarterly interest.
Different banks offer different interest rates on savings bank account. For
! !71
e.g. Kotak Mahindra Bank offers 6% p.a on the amount deposited in Kotak
savings account above a certain limit.
Features of Various Flavours of Savings Account Offered by Kotak

Mahindra Bank
There 811 Digital Bank Account can be opened with zero balance and given
within the convenience of the app . They also have a Junior - The Savings
Account for Kids that provide Personalized Junior Debit Card which has
exclusive privileges and discounts across kid’s brands and designed to
teach children the benefits of saving, while also providing a host of
privileges across dining, edutainment and shopping on kids’ brands. Their
Silk Women’s Savings Account provides Cash Back on Kotak Silk Debit Card
Spends and 35% discount on Locker Rentals for the first year. Their Pro
Savings Account provides multiple benefits and premium banking services.
Their Classic Savings Account can be opened only in semi urban and rural
locations. Their My Family Savings Account is specifically designed for the
customer to use this savings account together with his family and brings
the entire family’s banking needs under one account, allowing everyone to
avail exclusive family-centric benefits and features, and make the most of
their banking experience together. Their Sanman Savings Account is
designed to enjoy faster and secure access to all your banking needs with
low maintenance fees and cater to every banking need for Rural India.
Their Ace Savings Account is exclusively designed to give additional
advantages and banking benefits, Their Grand - Savings Programme offers
new-age senior citizens a plethora of benefits that are guaranteed to make
their lives comfortable and the privileges can be availed as early as when
! !72
you turn 55. Their Alpha - The Savings & Investment Programme is
specially designed to make regular saving to invest in Recurring Deposits,
NPS, Fixed Deposits, Mutual Fund and much more all in one place.
Source: https://www.kotak.com/en/personal-banking/accounts/savings-
account.html
For complete updated details please visit the branch.
Small finance banks offer higher interest rates than their larger peers.
Interest rates on savings accounts. For e,g, Ujjivan Small Finance Bank
offers 7 % pa interest rates on deposits over certain limit.
!
Source: https://www.ujjivansfb.in/support-interst-rates.html#saving-scroll
! !73
Ujjivan Small Finance Bank also offers a Basic Savings Bank Deposit
Account and a Institutional Segment (TASC): Savings Account.
The customer has to maintain a minimum balance in the account and the
withdrawal transactions are restricted. A cheque book and a debit card is
issued to the customer to withdraw money or make payment for
purchases.
Some banks also offer life insurance cover for its savings bank account
holders
Customer can deposit his cheques in the savings account and the bank acts
as an agent to collect the proceeds of the cheque if payable by some other
bank.
Nomination facility is available. Applicants are required to fill a form

prescribed under the Banking Companies (Nomination Rules), 1985
Axis Bank offers salary savings account which allows employees of an

organization seamless and convenient access to their salaries and
reimbursements. Salary bank account can be opened based on the job
profile and comes in 6 different variants depending on the nature of work.
The account differs in various ways like the daily withdrawal limit, shopping
limit, kind of debit card and so on. Various benefits ranging from Senior ID
cards for senior citizens, domestic travel plans, and higher interests to
dining delights, cashback on movie tickets etc. are provided to the
employees.
Current Deposit Account
"Current Account" shall mean a form of demand deposit wherefrom

withdrawals are allowed any number of times depending upon the balance
in the account or upto a particular agreed amount and shall also be
deemed to include other deposit accounts which are neither Savings
Deposit nor Term Deposit.
Current deposit Account is opened by businessmen to carry out day to day

business transactions. Individuals can also open current deposit account.
They don’t have any restrictions on transactions but no interest is paid on
! !74
the balances in the current account. Loans and advances are granted
though a current account.
Unlike in the case of Savings accounts, in current accounts customers can

deposit third party cheques endorsed to them.
Current account holders may have to pay some service charges depending
on the number of transactions and minimum balance maintained in the
account.

Axis Bank offers different flavours of current account as follows:
! !75
Cash Withdrawal Free Free Cash

Current Account
limit Transactions Deposit Facility
Normal Current Unlimited for Fixed charge of Upto Rs. 2 lakhs

Account Home Branch Rs. 50 per month per month for
with unlimited Home and Non
transactions Home branch cash
deposit
Local Current NA NA Upto Rs. 3 lakhs

Account per month for
home branch
Business Unlimited for Unlimited @ INR Upto Rs. 3 lakhs
Advantage home branch and 50/- per month for
Account Upto Rs. 3 lakhs Home and Non
per month for Non Home branch cash
home branch deposit
Business Select Unlimited for Fixed charge of Upto 12 times the

Account home branch and Rs. 50 per month Monthly Average
Upto Rs. 6 lakhs with unlimited Balance
per month for Non transactions maintained in the
home branch same cycle with
minimum free limit
of Rs. 6 lakhs per
month*
Business Classic Rs. 12 lakhs per Fixed charge of Upto Rs. 12 lakhs
Account month Rs. 50 per month per month for
with unlimited Home Branch and
transactions Non home branch
! !76
3.6 What are Term deposits or Time Deposits?
Term Deposit” shall mean a deposit received by the bank for a fixed period
and which is withdrawable only after the expiry of the said fixed period and
shall also include deposits such as Recurring/Cumulative/ Annuity/
Reinvestment deposits, Cash Certificates, and so on Term deposits or Time
deposits are opened for a fixed term and repayable on maturity. Unlike
demand deposits withdrawals are not permitted. However the customer
can avail loan on deposit or premature withdrawal in case of need.
A customer can primarily open a Fixed deposit account or a Recurring

deposit account as a term deposit or a time deposit. A fixed deposit
account enables the customer to make deposit in lumpsum, while a
recurring deposit account enables to make deposit of constant amount
periodically.
Term deposits are also called fixed deposits or time deposits enables the
customers to park their lumpsum money and avail of features like
guaranteed returns, choice of interest payout, liquidity through Over Draft
or premature withdrawal.
Fixed deposit can be opened for a certain period of time by depositing a

fixed amount of money, through a one-time investment. A predetermine
rate of interest is paidduring the tenure of the account, which assures
returns upon maturity.
A customer can open a fixed deposit for a minimum period of 7 days and a
maximum period of 10 years.
Interest rate can be fixed or floating. Banks are free to fix interest rates on
domestic term deposits.
Additional interest rate over that offered to general public is paid to senior
citizens and bank staff. Banks, with the permission of their Board, may
offer higher rate of interest on the term deposits of any size, to senior
citizens.
In respect of a term deposit maturing for payment on a Sunday or a

holiday or a non-business working day, a bank shall pay interest till the
next working day at the originally contracted rate.
! !77
Fixed deposits (FD) comes in two main flavors. In the first one customer
can get interest payment periodically at predetermined frequency such as
monthly, quarterly etc. In the second case the entire interest is paid on
maturity. If the entire interest is paid on maturity customer gets
compounded interest. Every quarter regular interest is added to the
principal for calculating the compound interest. Such plans in which the
interest is paid on maturity are also called Reinvestment Plan or
Cumulative plans.
Indian Banks’ Association (IBA) code for banking practice is issued by IBA
for uniform adoption by the Member Banks. IBA, for the purpose of
calculation of interest on domestic term deposit, have prescribed that on
deposits repayable in less than three months or where the terminal quarter
is incomplete, interest should be paid proportionately for the actual
number of days reckoning the year at 365 days.
In case of deposits of Rs.15 lakh and above banks may discriminate in the
matter of rate of interest between one deposit and another, accepted on
the same date and for the same maturity, on the basis of the size of
deposit.
Axis Bank has a special product named Fixed Deposit plus which has the
following features:
• Earn more with higher rates of return as compared to regular rates
• Option is available to all NRI and domestic customers
• The interest rate is available on a simple or compounding basis for a

minimum amount of Rs.15,00,001
• No maximum ceiling limit on investment amount
• Investment tenure can be customized from 7 days to 10 years
! !78
!
Source: https://www.axisbank.com/retail/deposits/fixed-deposit-plus
Banks are required to disclose in advance the schedule of interest rates

payable on deposits including deposits on which differential rate of interest
will be paid by the banks. Interest rates paid by a bank should be as per
the schedule and the same shall not be subject to negotiation between the
bank and the depositor for domestic deposits. Interest payable on deposits
and interest chargeable on advances shall be rounded off to the nearest
rupee
Banks are required to review their interest rate structure on domestic term
deposits of different maturities and take appropriate action to make them
comparable with the rates offered by the commercial banks.
Both individuals and non individuals can open fixed deposit account fo e.g.
• Residents
• Hindu undivided families
• Sole proprietorship firms
• Partnership firms
• Limited companies
! !79
• Trust accounts
Effective 01st April 2010, PAN is mandatory to book Fixed Deposits if the
total Fixed Deposit holding per customer exceeds 50,000/- TDS will be
deducted at applicable rate (currently 10%)when interest payable or
reinvested on fixed deposit per customer across all branches, exceed Rs.
10000 in a financial year. In the absence of PAN card, TDS will be deducted
at 20%.In case the total income including the interest on fixed deposit
does not exceed the minimum taxable slab then the customer can submit
Form 15G ( Non senior citizen) Dorm 15 H (senior citizen) with a request to
the Bank for not deducting Tax At Source. Such customers will be issued
interest certificate to enable them to submit complete information for filing
income tax returns.

Some banks also allow to book FD online through internet banking without
submitting physical form.
Some banks also offer Sweep-in facility which enables the customer to
have funds transferred to his Savings/Current account from Fixed Deposit if
the balance in your Savings/Current Account falls below a certain limit as
agreed by the customer. Sweep in of funds from Fixed Deposit (FD) to
Saving/ Current account triggers on Last in First out basis (LIFO).
Similarly Sweep-out facility enables the customer to have funds transferred

from his Savings/Current account to Fixed Deposit if the balance in your
Savings/Current Account goes above a certain limit as agreed by the
customer.
The main advantage of Sweep-in and Sweep-out facility is depositors can

earn higher interest on deposits until it is swept-in, while the remaining
Fixed Deposit continues to earn the predetermined interest. Some banks
also allow to link multiple deposits to your Savings Account and provide
flexibility in altering the period of deposit, maturity and payment
instruction and auto-renewal period. Some banks even allow top-up of
deposits in existing FD accounts. The best part of this facility is customers
don’t have to pay penalty on premature withdrawal subject to certain
conditions.
! !80
Axis Banks Encash 24 Flexi Deposit provides dual benefits of the liquidity of
a Savings Account and high earnings of a Fixed Deposit. With Axis Bank’s
Encash 24 Flexi Deposit, the depositor can link his existing Savings Account
which facilitates automatic transfer of money in multiples of Rs. 5,000 to a
Fixed Deposit when the balance in the Savings Account crosses Rs. 25,000.
With Encash 24 Flexi Deposit the depositor open a FD for a maximum
tenure of 5 years or avail short term benefit with a minimum tenure of 6
months.
Source: https://www.axisbank.com/retail/deposits/encash-24-flexi-
deposit/features-benefits
Banks are also permitted to issue 5 Year Tax Saving Fixed Deposit under
Section 80C of Income Tax Act, 1961. Customer can deposit upto 1.5 lakhs
p.a under section 80C and claim deduction from taxable income. There is a
lockin period of 5 years. In the case of joint deposits, the Tax benefit under
80 c will be available only to the first holder of the deposit.
State Bank of India has a Annuity Deposit Scheme in which the depositor
pay one time lump sum amount and to receive the same in Equated
Monthly Instalments (EMIs), comprising a part of the principal amount as
well as interest on the reducing principal amount, compounded at quarterly
! !81
rests and discounted to the monthly value. Payment of interest will start on
the anniversary date of the month following the month of deposit. If that
date is non-existent (29th, 30th & 31st), it will be paid on the 1st day of
the next month
!
Source: https://www.sbi.co.in/portal/web/personal-banking/annuity-
deposit-scheme
Most banks allow premature withdrawals of fixed deposit and get a Loan or
Overdraft up to 90% of the FD amount. Customer has to pay a penalty for
premature withdrawal. The interest paid on premature payment shall be
1% below the rate applicable at the time of keeping of deposits for the
period deposit remained with the Bank or 1% below the contracted rate,
whichever is lower. Every bank has its own rules on the rate of penalty.
Banks are free to determine their own penal interest rates for premature
withdrawal of term deposits. Banks should ensure that the depositors are
made aware of the applicable penal rate along with the deposit rate.
! !82
Banks, at its discretion, may disallow premature withdrawal of large

deposits held by entities other than individuals and Hindu Undivided
Families. Bank should, however, notify such depositors of its policy of
disallowing premature withdrawal in advance, i.e., at the time of accepting
such deposits.
Since overdraft against FD is a secured asset, most banks attract

customers with facilities such as interest on a daily reducing balance, zero
processing charges, no prepayment penalties. The security is in the form of
Lien mark on underlying FD.
The repayment schedule is fixed depending upon the repayment capacity

of the borrower Customers are also provided automatic renewals of their
FD without the need of going to the bank on maturity date for renewal of
FD. Such auto renewals will take place only where there is no maturity
instructions recorded at the time of opening the Term Deposit account or
any time before maturity of deposit.
State Bank of India has a special product under Resident Foreign Currency
(Domestic) Account which enables a resident Indian to open and maintain
a foreign currency account. The salient features are as follows:
Though all the above deposits are opened in Indian currency a Resident
Indian can open and maintain a foreign currency account to retain the
foreign exchange acquired through various means under Resident Foreign
Currency (Domestic) Account(RFC).
! !83
The various means include:
• Payment while on a visit abroad for services not arising out from any
business or anything done in India.
• Honorarium or gift or payment for services rendered/settlement of any

lawful obligation from any person not resident in India and who is on a
visit to India.
• Honorarium or gift while on a visit to any place outside India.
• Gift from a relative (subject to FEMA guidelines).
• Foreign exchange acquired from an authorized person for travel abroad,

if unspent.
• Amount received by the resident account holder as disinvestment

proceeds on conversion of shares held by him to ADRs/GDRs under the
DR Scheme, 2014
• Proceeds of life insurance policy claims/maturity/surrender values settled

in foreign currency from an insurance company in India permitted to
undertake life insurance business by the Insurance Regulatory and
Development Authority.
Withdrawals can be made for payment towards:
• Private visits to any country (except Nepal and Bhutan)

• Gift or donation
• Going abroad for employment.
• Emigration
• Maintenance of close relatives abroad
• Travel for business, or attending a conference or specialised training or
for meeting expenses for meeting medical expenses, or check-up abroad,
or for accompanying as attendant to a patient going abroad for medical
treatment/ check-up.
• Expenses in connection with medical treatment abroad
• Studies abroad
• Any other current account transaction
! !84
Following Capital Account transaction permissible under the FEMA

(Permissible Capital Account Transactions) Regulations, 2000;
• Opening of foreign currency account with a bank abroad

• Purchase of property abroad
• Making investment abroad – acquisition and holding of shares of both
listed and unlisted overseas company or debt instruments
• Setting up Wholly Owned Subsidiaries and Joint Ventures (with effect
from August 05, 2013) outside India for bona fide business subject to the
terms & conditions stipulated in notification no FEMA 263/RB-2013 dated
March 5, 2013.
• Extending loans including loans in Indian Rupees to Non-resident Indians
(NRIs) who are relatives as defined in Companies Act
Conversion of account balance: As per RBI guidelines, the sum total of

all the credits received in RFC (Domestic) account during a calendar
month, less amount utilised, should be converted into Indian Rupees
(crystallise) on or before the last working day of the succeeding calendar
month after making adjustments for forward commitments.
It is a Non-Interest bearing Current Account. The Minimum Balance

required to be maintained is USD 500, GBP 250 and EURO 500. The
balance in the account is freely repatriable.
! !85
Investment Term: Min: 1 Year, Max: 3 Years
Source: https://www.sbi.co.in/portal/web/personal-banking/rfc-domestic
State Bank of India’s https://www.sbi.co.in/portal/web/personal-

banking/sbi-capgains-plus-capital-gain also gives very useful
information on SBI CAPGAINS PLUS (CAPITAL GAIN SCHEME 1988) as
follows:
SBI Capgains Plus (Capital Gain Scheme 1988)
Sale proceeds of a plot of land or a flat or any such property can be parked
in SBI's CapGains Plus under the Capital Gains Account Scheme, 1988
inorder to become eligible to claim exemption of Long Term Capital Gains
Tax on sale of Capital Assets.
The depositor gets adequate time to acquire the new asset of choice and
earn interest at Savings Bank or Fixed Deposit rates during the wait
! !86
The period of deposit cannot exceed 2 to 3 years from the date of transfer
of original asset as given below:
Max 24 months: if capital gains is U/s 54, 54B, 54 F. (As declared in Form
A by depositor)
Max 36 months: if capital gains is U/s 54, 54 D, 54 F, 54 G & 54GB (As

declared in Form A by depositor)
At the time of closure of all accounts, the depositor will have to produce
specific authority letter/certificate from the Income Tax Officer of the
respective jurisdiction. The closure would be allowed on the terms
mentioned in the letter of authority.
Nomination facility is available for the deposits (Up to 3 Nominees can be

nominated)
Source: https://www.sbi.co.in/portal/web/personal-banking/sbi-capgains-
plus-capital-gain
! !87
Deposit Accounts of Non Resident Indians(NRIs)
In India, Non-resident accounts are opened and maintained by NRIs. A

non-resident is defined by Income Tax (I-T) Rules as well as by Foreign
Exchange Monitoring Act (FEMA),1999.
As per Income Tax Act 1961 if an assesse stays outside India for 182 days
in a financial year he is called a non-resident.
As per FEMA resident means a Person who has gone out of India or Who
stays outside India in either case for the following 3 purposes:
a. For or on taking up employment outside India or

b. For carrying on a business or vocation outside India
c. For any other purpose, in such circumstances, as would indicate his
intention to stay outside India for an uncertain period
NRE NRO FCNR (B)
Purpose To deposit income/ To deposit funds To deposit funds in

earnings from remitted from foreign currency,
abroad. overseas to India remitted from
Interest earned on or local income overseas to India
account can be from Indian
credited locally sources
Currency Rupees Rupees Designated foreign

currency such as
USD, GBP, EURO,
CAD, JPY, AUD
Types of account Savings, Current, Savings, Current, Only Fixed

Fixed Deposits Fixed Deposits Deposits
Investment Tenure Min: 1 Year Min: 7 Days Min: 1 Year

Max: 10 Years Max: 10 Years Max: 5 Years
Repatriability of Freely Repatriable Current income up Freely Repatriable

Principal to USD 1 million
(Conditional)
Repatriability of Freely Repatriable Freely Repatriable Freely Repatriable

Interest subject to
deduction of tax
! !88
Taxability in India Interest income Interest income is Interest income

tax free in India taxed as per India tax free in India
Income Tax Rules.
Reduced tax under
Double Tax
Avoidance
Agreement
A Non-Resident External Savings Account is opened by an NRI to deposit

foreign income earned outside India to earn tax-free interest.
A Non-Resident Ordinary Savings Account is opened by an NRI to deposit

his income earned in India such as rent, dividends, pension etc.
FCNR(B) is a fixed deposit held in foreign currency by NRI/PIO/OCIs who

wish to retain their money in foreign currency to avoid foreign currency
exchange risk, ensuring high and guaranteed returns
Operating the NRI Account with ICICI Bank FAQs: https://

www.icicibank.com/nri-banking/faq/accounts-and-deposits/opened-new-
nri-account-with-icici-bank-operating-account-faqs.page?
NRIs can operate your account through any of the following means:
• Internet Banking
• Phone Banking
• Branches in India
• Branches overseas
• Debit cum ATM card
• Mandate Holder
• Cheque Book
! !89
Internet Banking
Internet Banking provides you the convenience of operating your account

24 X 7 from the comfort of your home or office. Using this, you can place
requests like:
• Opening Fixed Deposits/Recurring Deposits

• Generate your Debit Card PIN
• Updation of PAN details
• Activation of Inactive/Dormant account
• Updation of Contact number/Email ID
• Request for Cheque Book/ATM/Debit Card
• Registration for e-statement facility
Phone Banking
The above requests can also be placed through our 24-hour Toll free
customer care lines . In case toll free lines are not available in your
country, you can take advantage of our click to call facility. Using this, you
can input your details on our website and our executives will get in touch
with you in the next five to ten minutes. Click here to know more about
this service.
Branches in India
On your visit to India, you can also make use of our wide network of 3500
branches in the country for operating your account.
Overseas
You can also operate your account from the branches at the following
locations overseas:
UK
Representative office in UAE – Dubai and Abu Dhabi
Singapore
HongKong
Bahrain
! !90
Debit/ATM card
You are given a debit cum ATM card with your NRI account. You can use
this card for withdrawing funds, shopping and much more. Also, this debit
card is required for authentication for transaction done using Internet or
Phone banking.
Please note that the debit cards linked to NRE accounts can be used at
merchant establishments overseas and on e-commerce portals whereas the
cards linked to NRO accounts can be used only on merchant
establishments in India and cannot be used on e-commerce portals.
Mandate Holder
Mandate holder is a person who can operate your NRI account in India on
your behalf. This person can perform transactions like:
Making local payments
Closing FDs on maturity or Renewing FDs
Opening additional FD in the same Customer ID
We give a cheque book and ATM card to your mandate holder to make it
easy for him to operate your account.
Cheque Book
A cheque book is given to you when you open a new NRI account.
If you need a new cheque book, you can place a request for the same
through your Internet Banking account by following the path below:
Login Service requests Cheque Book request
You can also call our 24-hour customer care or visit your nearest branch to
get a new cheque book. Click here to know the charges applicable for
ordering a new cheque book.
! !91
!
Source: https://www.icicibank.com/nri-banking/faq/accounts-and-
deposits/opened-new-nri-account-with-icici-bank-operating-account-
faqs.page?
Recurring Deposits(RD)
Recurring Deposit is a special kind of Term Deposit suitable for those who
do not have a lumpsum money to fulfil their dreams but wish to achieve
their dreams by potting together a fixed amount every month for
accumulation along with interest after a fixed period. Since deposits are
made in equal monthly installments, it reduces the burden of investing in
lump sum.
Most banks allow Recurring Deposit with tenure ranges from a minimum
period of six months, and to a maximum period of ten years.
Partial withdrawal is not allowed in Recurring Deposits. However premature

withdrawal is allowed with some penalty.
Recurring Deposit account cannot be renewed on maturity but upon the

completion of its maturity period, a new Recurring Deposit can be opened
for the same or different installment amount and tenure.
! !92
Recurring Deposits enables a customer to deposit constant amount

periodically. It helps the customer to build up savings through monthly
install to accumulate a targeted amount he wishes. On maturity i.e after a
fixed period the Bank returns the accumulated principal along with interest.
Recurring Deposits inculcate the habit of saving among the people as
investment is made as a fixed amount on monthly basis.
Nomination Facility is Available
The Recurring Deposit can be funded by Standing instructions which are

the instructions by the customer to the bank to withdraw a certain sum of
money from his Savings/ Current account and credit to the Recurring
Deposit account. Interest is compounded on quarterly basis in recurring
deposits. The best part of the Recurring deposit is interest rate is freezed
for the entire tenure of deposit which means even though the interest rate
fall subsequently all later installments will continue to enjoy the interest
rate offered at the time of opening the Recurring Deposit account.
The formula to calculate the interest on Recurring Deposit is as follows
I = P* n(n+1)r/2400
where;
I = Interest on Recurring Deposit

P = Principal amount
n = Time in months
r = Rate of interest per annum
If any installment is delayed, the interest payable in the account will be

reduced.
Customers can avail loans against Recurring deposit up to 90% of the

deposit value
Tax Deducted at Source (TDS) is applicable on Recurring deposits. If

interest earned on recurring deposits exceeds Rs. 10,000 a year, TDS at
the rate of 10% would be deducted by the bank. If the customer’s annual
income does not fall into the minimum taxable slab then he can according
submit Form 15G/H as the case be to avoid TDS on recurring deposits
! !93
Income tax is to be paid on interest earned from a Recurring Deposit at the

rate of tax slab of the Recurring Deposit holder.
Different Types of Recurring Deposit schemes
Variable Recurring Deposit(VRD) scheme
A recurring deposit scheme with the option of varying the monthly

installments is called the Variable Recurring deposit scheme.
The Variable RD scheme is highly beneficial for the lower income groups.
However, this scheme caters to people who want to save only a small
amount as well as large amounts.
Benefits of the Variable Recurring Deposit
• Interest rates are attractive and compounded on a quarterly basis

• Customers can deposit as much as they like and based on their income
generation
• Tenure can be 1 year up to a period of 10 years.
• Nomination possible
• Loan against VRD possible
• In case of delay in payment of monthly instalment no penalty is levied
Indian Bank is offering Variable Recurring Deposit Scheme.
! !94
!
Source: https://www.indianbank.in/variable-recurring-deposit/#!
A Flexi Recurring Deposit (FRD) offers both convenience and flexibility

to depositors, by allowing to invest lump sums as and when available.
The customer needs to first open a Flexi Recurring Deposit with a core
amount and then deposit any amount with every monthly installment,
based on the availability of funds.
The variable component of the recurring deposit can be incremented in

specific multiples with a cap on the amount to be invested.
The interest rate for the core amount is as per applicable rates for the
recurring deposit tenure, while the flexible portion carries an interest rate
from the deposit date.
The core amount has to be deposited on the pre-determined date or a

penalty will be imposed by the bank.
The flexible amount can be invested at any time of the month and no
penalty will be levied.
! !95
Flexi Recurring Deposits are offered by the following banks in India:
• iWish Flexible RD - ICICI Bank

• SBI Flexi Deposit - State Bank of India
• PNB Swecha Jama Yojna/Flexi RD - Punjab National Bank
• Star Flexi Recurring Deposit - Bank of India
• Flexi Recurring Deposit - IndusInd Bank
• Union Monthly Plus - Union Bank of India
• Corp Recur Deposit - Corporation Bank
• Canara Dhanvarsha - Flexi Recurring Deposit Scheme
• Flexi recurring - Cent Swa Shakti - Central Bank of India
• Money Mala Plus - Karur Vysya Bank
Source: https://www.bankbazaar.com/recurring-deposit/flexi-recurring-
deposit.html
ICICI Bank has a unique Recurring Deposit Scheme: Delightful Deposits -

Recurring Deposit with Rewarding Experience
Delightful Deposits! Delightful Deposits are Recurring Deposits (RD) in

association with our partners from sectors like travel, jewellery and
electronics. Delightful Deposits gives the customer more than the RD
interest, in the form of a top-up amount from their partner such as Croma,
Tanishq.
! !96
Salient features of Croma Delightful Deposit is as follows:
• Customer needs to open a Croma Delightful Deposit for a minimum

monthly instalment of Rs. 5,000 and in multiples of Rs.1,000 (thereon)
for either 6 months or 12 months with the instruction to transfer the
proceeds to the Croma Gift Voucher on maturity
• Earn interest on the Recurring Deposit (RD), up to 6.90 % per annum
• On maturity, the proceeds of your RD maturity (principal + interest) and
additional benefit from Croma will be transferred to a Croma Gift Voucher
• Customer can present the Croma Gift Voucher at any Croma outlet or use
it online at www.croma.com to purchase the electronic appliances of his
choice
Source: https://www.icicibank.com/Personal-Banking/account-deposit/
value-added-products/croma-isave2buy-rd.page?
! !97
3.7 National Pension System (NPS)
National Pension System is an unique initiative taken by Pension Fund

Regulatory & Development Authority (PFRDA) aimed at providing security
in the form of pension at old age as well as receive market based returns
on contributions made to the pension fund. National Pension System (NPS)
is administered and regulated by Pension Fund Regulatory and
Development Authority(PFRDA).
The following information is based on the PFRDA website https://

www.pfrda.org.in
National Pension System (NPS) is a voluntary, defined contribution

retirement savings scheme. It enables the subscriber to make systematic
savings during their working life. NPS seeks to inculcate the habit of saving
for retirement amongst the citizens.
Under the NPS, individual savings are pooled in to a pension fund which
are invested by PFRDA regulated professional fund managers as per the
approved investment guidelines in to the diversified portfolios comprising
of government bonds, bills, corporate debentures and shares. These
contributions would grow and accumulate over the years, depending on the
returns earned on the investment made.
At the time of normal exit from NPS, the subscribers may use the
accumulated pension wealth under the scheme to purchase a life annuity
from a PFRDA empanelled life insurance company apart from withdrawing a
part of the accumulated pension wealth as lump-sum.
NPS offers a range of investment options and choice of Pension Fund

Manager (PFMs) for planning the growth of investments
Opening an account with NPS provides a Permanent Retirement

Account Number (PRAN), which is a unique number and it remains with
the subscriber throughout his lifetime.
! !98
The scheme is structured into two tiers:
Tier-I account: This is the non-withdrawable permanent retirement

account into which the accumulations are deposited and invested as per
the option of the subscriber.
Tier-II account: This is a voluntary withdrawable account which is

allowed only when there is an active Tier I account in the name of the
subscriber. The withdrawals are permitted from this account as per the
needs of the subscriber as and when claimed.
NPS provides seamless portability across jobs and across locations
NPS is regulated by PFRDA, with transparent investment norms, regular

monitoring and performance review of fund managers by NPS Trust.
NPS architecture consists of NPS Trust which is entrusted with

safeguarding subscribers interests, a Central Record keeping Agency (CRA)
which maintains the data and records, Point of Presence (POP) and
aggregators as collection and distribution arms, competing pension fund
managers for generating and maximizing returns on investments of
subscribers, custodian to take care of the assets purchased by the Fund
managers and Trustee bank to manage the banking operations.
NPS has an unbundled Architecture, with inbuilt checks and balances,

where each function is performed by a different entity which is renowned in
its area, to achieve maximum operational efficiency and at a low cost.
NSDL is acting as Central Record Keeping agency (CRA) which is associated

with various national level proRenowned Financial Institutions covering
Public/Private Sector Banks, NBFC, etc., acting as POPs and
Aggregatorsjects for record keeping functions.
Funds are managed by professional Fund Managers from Public & Private
sector with proven track record and as per the PFRDA approved investment
guidelines. At present there are 8 pension fund managers managing the
pension wealth of subscribers. They are:
! !99
1. HDFC Pension Management Co. Ltd.

2. ICICI Prudential Pension Fund Management Co. Ltd.
3. Kotak Mahindra Pension Fund Ltd.
4. LIC Pension Fund Ltd.
5. Reliance Capital Pension Fund Ltd.
6. SBI Pension Funds Pvt. Ltd
7. UTI Retirement Solutions Ltd
8. Pension Fund (PF) to be incorporated by Birla Sunlife Insurance Co. Ltd
Axis Bank, functions as Trustee Bank
Stock Holding Corporation of India Ltd, functions as custodian for NPS.
Eligibility: All Citizens Model
A citizen of India, whether resident or non-resident, subject to the

following conditions:
1. Applicant should be between 18 – 65 years of age as on the date of

submission of his/her application to the POP/ POP-SP or opening
account online on eNPS platform.
2. Applicant should comply with the Know Your Customer (KYC) norms as
detailed in the Subscriber Registration Form. All the documents required
for KYC compliance need to be mandatorily submitted.
Corporate Model is available to any of the entities as under
• Entities registered under Companies Act

• Entities registered under various Co-operative Acts
• Central Public Sector Enterprises
• State Public Sector Enterprises
• Registered Partnership firm
• Registered Limited Liability Partnership (LLPs)
• Any Body incorporated under any act of Parliament or State legislature or
by order of Central/State Government
• Proprietorship Concern
• Trust/Society
! !100
The employees of the corporate entity, enrolled by the employer having

Indian Citizenship between the age of 18-65 years and complying with the
KYC norms, are eligible to be registered as subscribers under NPS.
Enrollment
To enroll in the NPS, applicant needs to submit the duly filled up Subscriber
Registration Form (as prescribed) to the POP-SP of his/her choice.
After the account is opened, CRA shall mail a “Welcome Kit” containing the
subscriber’s unique Permanent Retirement Account Number (PRAN) Card
and the complete information provided by the subscriber in the Subscriber
Registration form. This account number will be the primary means of
identifying and operating the account.
Applicant will also be provided an Internet Password (IPIN) for accessing

an account on the CRA Website (www.npscra.nsdl.co.in) on a 24X7 basis.
The subscriber has the option to open the account online through eNPS
platform available on NPS Trust website www.npstrust.org.in
Minimum Contributions (For Tier-I)
• Minimum contribution at the time of account opening and for all

subsequent transactions- Rs.500
• Minimum contribution per year - Rs.1,000 excluding charges and taxes
• Minimum number of contributions in a year - 01
Minimum Contributions (For Tier-II)
• Minimum contribution at the time of account opening - Rs.1000 and for

all subsequent transactions a minimum amount per contribution of Rs..
250
• There is no minimum contribution requirement for the financial year and

also there is no cap on maximum contribution
! !101
Investment choices
The NPS offers two approaches to invest subscriber’s money:
Active choice - Individual Funds (Asset Class E, Asset Class C, and Asset
Class G and Asset Class”A” )
Subscriber will have the option to actively decide as to how his/her NPS
pension wealth is to be invested in the following three options:
Asset Class E: Investments in predominantly equity market instruments.
Asset Class C: investments in fixed income instruments other than

Government securities.
Asset Class G: investments in Government securities.
Asset class A: Investment in Alternative Investment Schemes including

instrument like CMBS, MBS, REITS, AIFs, InvIts etc.
Subscriber can choose to invest his/her entire pension wealth in C or G

asset classes and up to a maximum of 50% in equity (Asset class E) and
upto a maximum of 5% in asset class “A”. Subscriber can also distribute
his/her pension wealth across E, C, G and A asset classes, subject to such
conditions as may be prescribed by PFRDA.
Auto choice - Lifecycle Fund
NPS offers an easy option for those participants who do not have the
required knowledge to manage their NPS investments. In case subscribers
are unable/unwilling to exercise any choice as regards asset allocation,
their funds will be invested in accordance with the Auto Choice option.
In this option, the investments will be made in a life-cycle fund. Here, the
proportion of funds invested across three asset classes will be determined
by a pre-defined portfolio (which would change as per age of subscriber),
with the investment in E decreasing and in C & G increasing with the age of
the subscriber.
! !102
Three Life Cycle funds are available under this Auto Choice:
1. LC75 – Aggressive Life Cycle Fund: In this Life Cycle Fund, the
exposure in Equity Investments starts with 75% till age 35 and
gradually reduces as per the age of the subscriber.
2. LC50- Moderate Life Cycle Fund: In this Life Cycle Fund, the exposure
in Equity Investments starts with 50% till age 35 and gradually reduces
as per the age of the subscriber.
3. LC 25- Conservative Life Cycle fund: In this Life Cycle Fund, the
The default auto choice if the subscriber is not choosing any of the above
option is Moderate life Cycle Fund.
Withdrawal/Exit
(A) Upon Attainment of the age of 60 years:
At least 40% of the accumulated pension wealth of the subscriber needs to

be utilized for purchase of annuity providing for monthly pension to the
subscriber and balance is paid as lump sum payment to the subscriber. In
case the total accumulated corpus is less than Rs. 2 Lacs, the subscriber
may opt for 100% lumpsum withdrawal.
However, the subscriber has the option to defer the lump sum withdrawal
till the age of 70 years. Subscriber has also got the option to continue
contributing upto the age of 70 years. This option is required to be
exercised upto 15 days prior to completion of 60 years.
(B) At any time before attaining the age of 60 years
The subscriber may exit from NPS before attaining the age of 60 years,
only if he has completed 10years in NPS. At least 80% of the accumulated
pension wealth of the subscriber needs to be utilized for purchase of
annuity providing for monthly pension to the subscriber and the balance is
paid as a lump sum payment to the subscriber.
! !103
In case the total accumulated corpus is less than Rs. 1 Lac, the subscriber
may opt for 100% lumpsum withdrawal
(C) Death of the subscriber
In such an unfortunate event, option will be available to the nominee to

receive 100% of the NPS pension wealth in lump sum. However, if the
nominee wishes to continue with the NPS, he/she shall have to subscribe to
NPS individually after following due KYC procedure
Under National Pension System, PFRDA has entrusted the responsibility of

receiving, processing and settlement of all withdrawal claims made to
Central Record keeping Agency (CRA) and CRA has created a special NPS
claim processing cell (NPSCPC) for this purpose for handling all types of
withdrawal claims. The CRA will monitor the performance of NPSCPC on the
withdrawal processing as per the instructions provided by PFRDA in this
regard. At present the NPSCPC is fully functional.
The subscribers can submit their claims online for withdrawal from NPS
Benefits of NPS
Low Cost: NPS is considered to be the world’s lowest cost pension

scheme. Administrative charges and fund management fee are also lowest.
The account maintenance costs under NPS are the lowest as compared to
similar pension products available in India. It can mean a lot for a long
term account till retirement.
Till the retirement pension wealth accumulation grows over a period of

time with a compounding effect
Subscribers have control on the choice of investment made (Active or

Auto Choice) and the Pension funds who manages the investments. NPS
account can be accessed online to make contributions and track
investments.
Subscribers can switch from one Pension fund to another, one

investment option to another, subject to certain regulatory restrictions.
! !104
Three Life Cycle funds are available under this Auto Choice
1. LC75 – Aggressive Life Cycle Fund: In this Life Cycle Fund, the
2. LC50- Moderate Life Cycle Fund: In this Life Cycle Fund, the exposure
in Equity Investments starts with 50% till age 35 and gradually reduces
as per the age of the subscriber.
3. LC 25- Conservative life cycle fund: In this Life Cycle Fund, the
Tax benefits for salaried
Individuals who are employed and contributing to NPS would enjoy tax
benefits on their own contributions as well as their employer’s contribution
as under:
a. Employee’s own contribution - Eligible for tax deduction up to 10% of

Salary (Basic + DA) under Section 80 CCD(1) within the overall ceiling
of Rs.1.50 lacs under Sec 80 CCE.
b. Employer’s contribution – The employee is eligible for tax deduction up

to 10% of Salary (Basic + DA) contributed by employer under Sec 80
CCD(2) over and above the limit of Rs.1.50 lacs provided under Sec 80
CCE.
Tax benefit for self-employed:
Eligible for tax deduction up to 20 % of gross income under Sec 80 CCD

(1) with in the overall ceiling of Rs.1.50 lacs under Sec 80 CCE.
Subscriber is allowed deduction in addition to the deduction allowed under

Sec. 80CCD(1) for additional contribution in his NPS account subject to
maximum investment of Rs. 50,000 under sec. 80CCD 1(B)
Tax benefits would be applicable as per the Income Tax Act, 1961 as
amended from time to time.
! !105
A safe retirement fund: Introduced by the Government of India and

regulated by the Pension Fund Regulatory & Development Authority
(PFRDA).
Simple - All applicant has to do is to open an account with any one of the
POPs or through eNPS and get a Permanent Retirement Account
Number(PRAN)
Flexible - Applicant can choose his/her own investment option and

Pension Fund or select Auto choice to get better returns.
Portable - Applicant can operate an account from anywhere in the country

and can pay contributions through any of the POP-SPs irrespective of the
POP-SP branch with whom the applicant is registered, even if he/she
changes his/her city, job etc and also make contribution through eNPS. The
account can be shifted to any other sector like Government Sector,
Corporate Model in case the subscriber gets the employment
Prudentially Regulated – Transparent investment norms, regular

monitoring and performance review of funds by NPS Trust.
!
Source: https://www.pfrda.org.in
! !106
3.8 Summary
Banks are the oldest institutions not only in India but across the world that
accept various types of deposits and use these funds for granting loans.
The business of banking is that of an financial intermediary between a
saver who lends money and the borrower who invests money into his
business. Customers are offered different types of deposit accounts based
on their time or demand liability preferences. The banking industry has
evolved since the ancient times and has made seamless developments in
range of products driven by technology advancement.
The Banking system in India is regulated by the Reserve Bank of

India(RBI) which is considered as the Central Bank in terms of the
Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949.
RBI plays an important role in ensuring the safety and soundness of the
banking system and in maintaining the financial stability and public
confidence in the system. The Banking Regulation Act,1949 was enacted to
provide a suitable framework for regulating the banking companies.
Indian Banking Industry consists of a large number of commercial and

cooperative banks, specialized development banks. Deposit accounts can
be opened in the name of one or more individuals. Demand deposits are
deposits accepted by the Bank from the customers and repayable as and
when required by the customers i.e on demand. A customer can open a
savings bank account or a current deposit account as a demand deposit.
Term deposits or Time deposits are opened for a fixed term and repayable
on maturity. In India, Non-resident accounts are opened and maintained by
NRIs. An NRI can open a NRE, NRO and FCNR account.
National Pension System is an unique initiative taken by Pension Fund

Regulatory & Development Authority (PFRDA) aimed at providing security
in the form of pension at old age as well as receive market based returns
on contributions made to the pension fund.
! !107
1. Explain the impact of technology on Banking industry
2. Explain the regulatory framework for Banks in India.
3. Explain the role of RBI in ensuring the safety and soundness of the
banking system.
4. Briefly explain Banking Regulation Act, 1949
5. What are the different types of Banking Companies accepting deposits

from the customer?
6. What is a scheduled bank?
7. Explain the different types of Bank Deposits
8. What is the difference between demand deposits and time deposits?
9. Explain the features of a savings account and a current account.
10. What are the different types of account opened by a non resident
Indian?
11. What is a Recurring Deposit account and how is it different from fixed
deposit account?
12. What is a National Pension Scheme?
13. What are the benefits of National Pension Scheme?
! !108
1. The Banking system in India is regulated by the Reserve Bank of

India(RBI) which is considered as the Central Bank in terms of the
Reserve Bank of India Act, 1934 and the Banking Regulation Act, 1949.
State whether the above statement is true or false.
a. True
b. False
2. Savings bank account are usually opened by Individuals who wish to

save a part of the current income to meet the future needs as well as to
earn interest on the amount that remains as a balance in the account.
Interest on savings account is calculated
a. on the minimum balance from the 10th of the moth till the end of the
month
b. on a daily balance basis
c. on a quarterly basis
d. on a half yearly basis
3. A Non-Resident External Savings Account is opened by an NRI to

deposit foreign income earned outside India to earn tax-free interest. In
which of the following type of NRI accounts principal amount is not
freely repatriable?
a. NRE
b. FCNR(B)
c. NRO
d. RFC
4. Recurring Deposit is a special kind of Term Deposit suitable for those

who do not have a lumpsum money to fulfil their dreams but wish to
achieve their dreams by potting together a fixed amount every month
for accumulation along with interest after a fixed period. Which of the
following statement relating to Recurring Deposit is not correct?
a. Loan against Recurring Deposit possible
b. In case of delay in payment of monthly installment penalty is levied
c. Tax Deducted at Source is not applicable
d. Nomination possible
! !109
5. National Pension System is an unique initiative taken by Pension Fund

Regulatory & Development Authority (PFRDA) aimed at providing
security in the form of pension at old age as well as receive market
based returns on contributions made to the pension fund Which of the
following is a benefit of NPS to the subscribers?
a. Low cost
b. Subscribers have control
c. Portable
d. All of the above
Ans: 1 - (a), 2 - (b), 3 - (c), 4 - (c), 5 - (d)
3.10 References
1. Banking and Finance by Clifford Gomez
2. Money and Banking by Nadar E.N
3. Indian Banking January by R Parameswaran and S Natarajan
4. Banking in India by M. S. Shetty
5. Elements of Banking and Insurance by Jyotsna Sethi and Nishwan

Bhatia
6. https://www.rbi.org.in
7. https://www.pfrda.org.in
8. Banking System in India: Reforms & Performance Evaluation by S. M.

Jawed Akhtar
9. Retail Banking by Keith Pond
10.Banking Products And Services by Indian Institute Of Banking & Finance
11.Banking: A Very Short Introduction by John Goddard and John O. S.

Wilson
! !110
12.Seventy Years of Banking System in India: 1947-48 to 2016-17 by Niti

Bhasin
13.Modern Commercial Banking by H.R. Machiraju
14.Money, Banking and Financial Markets by Stephen G. Cecchetti and

Kermit L. Schoenholtz
15.The Economics of Money, Banking and Financial Markets by Frederic S.

Mishkin
16.Introduction to Banking by Vijayaragavan Iyengar

17.Banking Services and Customer Protection by P. D. Shenoy and T Y
Prabhu
18.The Changing Geography of Banking and Finance by Pietro Alessandrini

and Professor Michele Fratianni 
! !111
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !112
POST OFFICE INVESTMENT SCHEMES
Chapter 4
Post Office Investment Schemes
Objectives:
This chapter will help you understand various post office investment
schemes of Department of Posts (DoP) which has played a crucial role in
the country’s social economic development. It will also help you understand
the Small Savings Schemes (SSS) launched by Central Government to
mobilise household savings through post office schemes.
Structure:
4.1 Introduction
4.2 Post Office Savings Account
4.3 5Year Post Office Recurring Deposit Account (RD)
4.4 Post Office Time Deposit Account (TD)
4.5 Post Office Monthly Income Scheme Account (MIS)
4.6 Senior Citizen Savings Scheme (SCSS)
4.7 15year Public Provident Fund Account (PPF)
4.8 National Savings Certificates (NSC)
4.9 Kisan Vikas Patra (KVP)
4.10 Sukanya Samriddhi Accounts
4.11 Summary
4.13 References
! !113
4.1 Introduction
The Department of Posts (DoP) has been touching the lives of Indian
citizens by delivering mails, accepting deposits under Small Savings
Schemes, providing life insurance cover under Postal Life Insurance (PLI)
and Rural Postal Life Insurance (RPLI), providing retail services like bill
collection, sale of forms, etc. for over 150 years. With 1, 55,015 Post
Offices, the DoP has the most widely distributed postal network in the
world. In order to further penetrate the unbanked and underbanked areas
with banking services the India Post Payments Bank (IPPB) was set up
recently under the Department of Posts (DoP), Ministry of Communication
with 100% equity owned by Government of India. IPPB offers a wide range
of services including accepting deposits, enabling money transfers, selling
third party products, facilitating bills and utility payments, supporting
digital payments for e-commerce and many more.
By using technology to drive its business and align to the needs of the
consumers, the Department of Posts (DoP) has launched various schemes
meeting almost every needs of investors not only residing at the cities but
also the grass root levels.
The Post Office Saving Schemes includes Post Office Savings Account, 5-
Year Post Office Recurring Deposit Account (RD), Post Office Time Deposit
Account (TD), Post Office Monthly Income Scheme Account (MIS), Senior
Citizen Savings Scheme (SCSS), 15 year Public Provident Fund Account
(PPF), National Savings Certificates (NSC), Kisan Vikas Patra (KVP),
Sukanya Samriddhi Accounts etc.
The best part of these investment is linking of interest rates to government

bond yields. Interest rates are reset every quarter based on the average
yield on government bonds of similar maturity in previous quarter. Since
the interest rate is formula driven, with rise in yields, post office deposits
ma fetch higher returns than bank deposits.
The following information on various Post Office Saving Schemes (mostly

as it is) is based on information available on https://www.indiapost.gov.in.
! !114
4.2 Post Office Savings Account
The Post Office Savings Account is meant for those who want to save
regularly as well as withdraw s and when they need money.
The Post Office Savings Account can be opened with a minimum amount of
Rs. 20 and pays interest at 4% per annum.
Salient features of Post Office Savings Account:
• Account can be opened by cash only
• Minimum balance to be maintained in a non-Cheque facility account is

Rs. 50
• Cheque facility available if an account is opened with INR 500. Minimum

balance of Rs. 500 in an account is to be maintained
• Nomination facility is available at the time of opening and also after

opening of account
• One account can be opened in one post office
• Account can be transferred from one post office to another
• Account can be opened in the name of minor. Minor of 10 years and

above age can open and operate the account
• Minor after attaining majority has to apply for conversion of the account
in his name
• Joint account can be opened by two or three adults
• At least one transaction of deposit or withdrawal in three financial years

is necessary to keep the account active
• ATM facility is available
• Deposits and withdrawals can be done through any electronic mode in

CBS Post offices.
! !115
• Interest earned is Tax Free up to INR Rs. 10,000 per year
4.3 5-Year Post Office Recurring Deposit Account (RD)
Recurring deposit account can be opened by those customers who can save
constant amount periodically for taking the lumpsum on maturity to meet
their financial goals.
The minimum amount for opening of 5-Year Post Office Recurring Deposit
Account (RD) is Rs. 10 per month. A customer can also deposit any
amount in multiples of INR 5/-. No maximum limit.
From 1.10.2018, interest rates on 5-Year Post Office Recurring

Deposit Account (RD) are as follows:-
7.3% per annum (quarterly compounded)
On maturity INR 10 account fetches INR 725.05.
Can be continued for another 5 years on year to year basis
Salient features of 5-Year Post Office Recurring Deposit Account

(RD)
• Account can be opened by cash/Cheque and in case of Cheque the date

of deposit shall be date of presentation of Cheque
• Subsequent deposit can be made up to 15th day of next month if account

is opened up to 15th of a calendar month and up to last working day of
next month if account is opened between 16th day and last working day
of a calendar month.
• In case of deposits made in RD accounts by Cheque, date of credit of

Cheque into Government accounts shall be treated as date of deposit.
• If subsequent deposit is not made up to the prescribed day, a default fee

is charged for each default, default fee @ 0.05 rs for every 5 rupee shall
be charged. After 4 regular defaults, the account becomes discontinued
and can be revived in two months but if the same is not revived within
this period, no further deposit can be made.
! !116
• If in any RD account, there is monthly default amount, the depositor has

to first pay the defaulted monthly deposit with default fee and then pay
the current month deposit. This will be applicable for both CBS and non
CBS Post offices.
• There is rebate on advance deposit of at least 6 installments
• Any number of accounts can be opened in any post office
• Joint account can be opened by two adults
• Single account can be converted into Joint and Vice Versa
• Account can be opened in the name of minor. A minor of 10 years and

in his name

opening of account
• One withdrawal up to 50% of the balance allowed after one year. It may
be repaid in one lumpsum along with interest at the prescribed rate at
any time during the currency of the account
• Full maturity value allowed on R.D. Accounts restricted to that of INR.

50/- denomination in case of death of depositor subject to fulfillment of
certain conditions.
! !117
4.4 Post Office Time Deposit Account (TD)
The Post Office Time Deposit Account (TD) is preferred by those customers
who have lumpsum amount to deposit and want to make their money grow
for accomplishing life goals.
The minimum amount for opening of account is Rs. 200/- and in multiple
thereof. There is no maximum limit.
Interest payable annually as per the following chart but calculated

quarterly.
Interest rates From 1.10.2018
Period Rate
1yr.A/c 6.9%
2yr.A/c 7.0%
3yr.A/c 7.2%
5yr.A/c 7.8%
Salient Features of Post Office Time Deposit Account (TD)
• Account may be opened by individual

of realization of Cheque in Govt. account shall be date of opening of
account
• Any number of accounts can be opened in any post office
• Account can be opened in the name of minor. A a minor of 10 years and

in his name
! !118
• Joint account can be opened by two adults

opening of account
• In CBS Post offices ,when any TD account is matured, the same TD

account will be automatically renewed for the period for which the
account was initially opened . Interest rate applicable on the day of
maturity will be applied
• The investment under 5 Years TD qualifies for the benefit of Section 80C
of the Income Tax Act, 1961
4.5 Post Office Monthly Income Scheme Account (MIS)
The Post Office Monthly Income Scheme Account (MIS) is preferred by

those investors who want to invest their lumpsum savings and want
periodical returns in the form of interest earned on the deposit.
The main aim of this scheme is to provide the investor a regular stream of
income in the form of interest through the duration of the investment
instead of giving a lump sum on maturity.
The minimum amount for opening of account is in In multiples of INR

1500/-. The maximum investment limit is Rs. 4.5 lakh in single account
and Rs. 9 lakh in joint account. An individual can invest maximum Rs. 4.5
lakh in MIS (including his share in joint accounts). For calculation of share
of an individual in joint account, each joint holder have equal share in each
joint account.
From 1.01.2018, interest rates on Post Office Monthly Income Scheme

Account (MIS) is 7.3% per annum payable monthly.
! !119
Salient Features of Post Office Monthly Income Scheme Account

(MIS)
• Account may be opened by individual

account
• Any number of accounts can be opened in any post office subject to

maximum investment limit by adding balance in all accounts
• Account can be opened in the name of minor and a minor of 10 years

and above age can open and operate the account
• Joint account can be opened by two or three adults
• All joint account holders have equal share in each joint account
• Maturity period is 5 years

opening of account
in his name
• Interest can be drawn through auto credit into savings account standing
at same post office, through PDCs or ECS./In case of MIS accounts
standing at CBS Post offices, monthly interest can be credited into
savings account standing at any CBS Post offices.
• Can be prematurely en-cashed after one year but before 3 years at the
discount of 2% of the deposit and after 3 years at the discount of 1% of
the deposit. (Discount means deduction from the deposit.)
! !120
4.6 Senior Citizen Savings Scheme (SCSS)
The Senior Citizen Savings Scheme (SCSS) is specially meant for

encouraging senior citizens with age of 60 years or more to invest and get
more interest rate.
The Senior Citizens' Saving Scheme (SCSS) was introduced by the

government in August 2004 as a fixed deposit scheme that gave senior
citizens assured returns at regular intervals.
There shall be only one deposit in the account in multiple of Rs. 1000/-
maximum not exceeding Rs. 15 lakh.
From 1.10.2018, interest rates on Senior Citizen Savings Scheme (SCSS) is

8.7% per annum, payable from the date of deposit of 31st March/30th
Sept/31st December in the first instance & thereafter, interest shall be
payable on 31st March, 30th June, 30th Sept and 31st December.
Salient features of Senior Citizen Savings Scheme (SCSS)
• An individual of the age of 60 years or more may open the account.
• An individual of the age of 55 years or more but less than 60 years who
has retired on superannuation or under VRS can also open account
subject to the condition that the account is opened within one month of
receipt of retirement benefits and amount should not exceed the amount
of retirement benefits.
• Maturity period is 5 years
• A depositor may operate more than one account in individual capacity or

jointly with spouse (husband/wife).
• Account can be opened by cash for the amount below Rs. 1 lakh and for
Rs. 1 Lakh and above by C heque only.
• In case of Cheque, the date of realization of Cheque in Govt. account

shall be date of opening of account.
! !121
• Any number of accounts can be opened in any post office subject to

maximum investment limit by adding balance in all accounts.
• Joint account can be opened with spouse only and first depositor in Joint
account is the investor.
• Interest can be drawn through auto credit into savings account standing
at same post office, through PDCs or Money Order.

opening of account
• In case of SCSS accounts, quarterly interest shall be payable on 1st

working day of April, July, October and January. It will be applicable at all
CBS Post Offices.
• Quarterly interest of SCSS accounts standing at CBS Post offices can be

credited in any savings account standing at any other CBS post offices
• Premature closure is allowed after one year on deduction of an amount

equal to1.5% of the deposit & after 2 years 1% of the deposit.
• After maturity, the account can be extended for further three years
within one year of the maturity by giving application in prescribed
format. In such cases, account can be closed at any time after expiry of
one year of extension without any deduction.
• TDS is deducted at source on interest if the interest amount is more than

INR 10,000/- p.a.
• Investment under this scheme qualifies for the benefit of Section 80C of
the Income Tax Act, 1961
! !122
4.7 15 year Public Provident Fund Account (PPF)
The 15 year Public Provident Fund Account (PPF) is a long-term investment

and is debt scheme under Government of India on which the investor earns
regular interest. A PPF account matures after the completion of 15 years
from the end of the year in which the account was opened. The long
maturity is intended to save for the future and utilize money during the pre
retirement or post retirement period of life for important things such as self
employment, fulifiling life goals etc.
Withdrawal from PPF account is permissible every year from the seventh
financial. PPF account holders have an option of extending their accounts
after the 15 year tenure with or without further subscription, for any period
in a block of five years.
Deposits in a PPF account qualify for a deduction under section 80C.

Furthermore, the entire maturity amount including the interest is non-
taxable. Not only is the interest earned tax free, PPF deposits are exempt
from wealth tax too.
From 1.10.2018, interest rates on 15 year Public Provident Fund Account

(PPF) is 8% per annum (compounded yearly).
The minimum Amount for opening of 15 year Public Provident Fund

Account (PPF) is Rs. 500 Maximum INR. 1,50,000 in a financial year.
Deposits can be made in lump-sum or in 12 installments.
! !123
Salient features of 15 year Public Provident Fund Account (PPF)
• An individual can open account with Rs. 100 but has to deposit minimum
of Rs. 500 in a financial year and maximum Rs. 1,50,000
• Joint account cannot be opened.
• Account can be opened by cash/Cheque and In case of Cheque, the date

account.
• The subscriber can open another account in the name of minors but
subject to maximum investment limit by adding balance in all accounts.

opening of account. Account can be transferred from one post office to
another.
• Maturity period is 15 years but the same can be extended within one
year of maturity for further 5 years and so on.
• Maturity value can be retained without extension and without further

deposits also.
• Premature closure is not allowed before 15 years.
• Deposits qualify for deduction from income under Sec. 80C of IT Act.
• Interest is completely tax-free.
• Withdrawal is permissible every year from 7th financial year from the
year of opening account.
• Loan facility available from 3rd financial year.
• No attachment under court decree order
! !124
4.8 National Savings Certificates (NSC)
The National Savings Certificates (NSC), popularly known as NSC, is like an

Indian Government Savings Bond, primarily used for small savings and
income tax saving investments. These are issued for five year maturity and
can be pledged to banks as collateral for availing loans. The holder gets the
tax benefit under Section 80C of Income Tax Act, 1961
The minimum Amount for opening of account is Rs.100/- and in multiples

of Rs. 100/- There is no maximum Limit.
From 1.10.2018, interest rates on National Savings Certificates (NSC) is

8% compounded annually but payable at maturity. Rs. 100/- grows to INR
146.93 after 5 years.
Salient features of National Savings Certificates (NSC)
• Encourages habit of savings amongst Indians
• This is a one time investment ideal for people looking for safety and
average or above average returns
• Investment procedure is easy and simple
• Available mostly in physical form
• A good rate of return, safety and tax benefits
• Interest rate stays the same throughout the duration of the certificate
• A single holder type certificate can be purchased by, an adult for himself
or on behalf of a minor or by a minor.
• The interest accruing annually but deemed to be reinvested under

Section 80C of IT Act.
• Interest can be shown on a yearly basis or by adding the total interest

earned on maturity to the total income
• Deposits upto Rs. 150000 qualify for tax rebate under Sec. 80C of IT Act.
! !125
• In case of NSC VIII, transfer of certificates from one person to another

can be done only once from date of issue to date of maturity.
• At the time of transfer of Certificates from one person to another, old

certificates will not be discharged. Name of old holder shall be rounded
and name of new holder shall be written on the old certificate and on the
purchase application(in case of non CBS Post offices) under dated
signatures of the authorized Postmaster along with his designation stamp
and date stamp of Post office
• In case of loss of original investor can apply for a duplicate certificate.
• Premature encashment of the NSC certificate is not permissible. The

certificates can only be encashed in event of the death of the holder or
forfeiture by a pledge or on the order of the courts
4.9 Kisan Vikas Patra (KVP)
The Kisan Vikas Patra (KVP) is a saving certificate scheme available in the
denominations of Rs. 1000, Rs. 5000, Rs. 10000 and Rs. 50000. The
minimum amount that can be invested is Rs. 1000. However, there is no
upper limit on the purchase of KVPs.
From 1.10 2018, interest rates on Kisan Vikas Patra (KVP) is 7.7%
compounded annually. Amount Invested doubles in 112 months (9 years &
4 months).
Salient Features of Kisan Vikas Patra (KVP)
• Encourages habit of savings amongst Indians
• This is a one time investment
• Investment procedure is easy and simple
• Available mostly in physical form
• Certificate can be purchased by an adult for himself or on behalf of a

minor or by two adults.
! !126
• Interest can be shown on a yearly basis (accrual method)or by adding

the total interest earned on maturity to the total income(receipt method)
• KVP can be purchased from any Departmental Post office.
• Facility of nomination is available
• Certificate can be transferred from one person to another and from one
post office to another.
• Certificate can be encash after 2 & 1/2 years from the date of issue
• A good rate of return, safety and tax benefits
• Interest rate stays the same throughout the duration of the certificate
Some tools are available online to calculate about maturity date and value
for this scheme, such as http://www.dailytools.in/
GovernmentSavingSchemes/KisanVikasPatra
Premature encashment of the KVP certificate is not permissible. The

certificates can only be encashed in event of the death of the holder or
forfeiture by a pledge or on the order of the courts
4.10 Sukanya Samriddhi Yojana Accounts
Sukanya Samriddhi Yojana is a small deposit scheme of the Government of

India meant exclusively for a girl child. The Sukanya Samriddhi Yojana is as
girl child prosperity scheme under Beti Bachao Beti padhao program of the
Prime Minister of India. The scheme is meant to meet the education and
marriage expenses of a girl child. The interest accrued and maturity
amount are exempt from tax. The Sukanya Samriddhi Yojana calculator
helps the investor to calculate the maturity amount at the end of the
tenure. The investor can use the calculator to find out how much he can
approximately save via this scheme for the daughter's higher education
and/or marriage.
From 1-10-2018 interest rate on Sukanya Samriddhi Yojana Accounts is

8.5% Per annum and is calculated on yearly basis with yearly
compounding.
! !127
The minimum amount for opening of account is Rs. 1000/-and the

maximum amount is Rs. 1,50,000/- in a financial year. Subsequent deposit
can be done in multiple of INR 100/- Deposits can be made in lump-sum.
There is no limit on number of deposits either in a month or in a Financial
year.
Salient Features of Sukanya Samriddhi Yojana Accounts
• A legal Guardian/Natural Guardian can open account in the name of Girl

Child
• A guardian can open only one account in the name of one girl child and
maximum two accounts in the name of two different Girl children.
• The third account in the name of the girl child can be opened in the event
of birth of twin girls, as second birth or if the first birth itself results in
three girl children.
• Account can be opened up to age of 10 years only from the date of birth.
• If minimum Rs. 1000 is not deposited in a financial year, account will

become discontinued and can be revived with a penalty of Rs. 50 per
year with minimum amount required for deposit for that year.
• Partial withdrawal, maximum up to 50% of balance standing at the end

of the preceding financial year can be taken after Account holder’s
attaining age of 18 years.
• Account can be closed after completion of 21 years.
• Normal Premature closure will be allowed after completion of 18 years/

provided that girl is married
• The deposits made to the account, and also the proceeds and maturity
amount are fully exempt from tax under section 80C of the Income Tax
Act.
• Various banks have also been authorized to open accounts under the
Sukanya Samriddhi Scheme e.g. State Bank of India
! !128
Source: https://sbi.co.in (information provided is as follows)
SUKANYA SAMRIDDHI ACCOUNT
SUKANYA SAMRIDDHI ACCOUNT: FACILITY AVAILABLE AT ALL OUR

BRANCHES
Sukanya Samriddhi Account has been introduced vide Government of

India Notification No. G.S.R.863(E) dated December 02, 2014 and
circulated to Banks by Reserve Bank of India vide their letter No.RBI/
2014-15/494/IDMD(DGBA).CDD/No.4052/15.02.006/2014-15 dated 11th
March 2015. Facility to open accounts under the scheme is now available at
all SBI branches.
Objective: To promote the welfare of Girl Child
WHO CAN OPEN THE ACCOUNT: A natural/legal guardian on behalf of a

girl child
MAXIMUM NUMBER OF ACCOUNTS: Upto two girl children or three in

case of twin girls as second birth or the first birth itself results in three girl
children
! !129
MINIMUM AND MAXIMUM AMOUNT OF DEPOSIT: Min.1000 of initial

deposit with multiple of one hundred rupees thereafter with annual ceiling
of Rs. 150000 in a financial year
Tenure of the Deposit: 21 years from the date of opening of the account
Maximum period upto which deposits can be made: 15 years from the date
of opening of the account.
Interest on Deposit: As notified by the GOI, compounded annually with

option for monthly interest pay-outs to be calculated on balance in
completed thousands. (Current rate 8.60%w.e.f 1st April, 2016)
Tax Rebate: As applicable under section 80C of the IT Act, 1961. In the
latest Finance Bill, the scheme has been extended Triple exempt benefits
i.e. there will be no tax on the amount invested, amount earned as interest
and amount withdrawn.
Premature Closure: Allowed in the event of death of the depositor or in

cases of extreme compassionate grounds such as medical support in life
threatening diseases to be authorized by an order by the Central
Government
IRREGULAR PAYMENT/REVIVAL OF ACCOUNT: By payment of penalty

of Rs.50 per year alongwith the minimum specified amount per year
Mode of Deposit: Cash/Cheque/Demand Draft/Transfer/online transfers

through internet Banking .
SIP: Standing Instructions can be given either at the Branch or set

through Internet Banking for automatic credit to Sukanya Samriddhi
Account.
Withdrawal: 50% of the balance lying in the account as at the end of

previous financial year for the purpose of higher education, marriage after
attaining the age of 18 years.
Note: As this is a Govt. of India scheme, customers are advised to

visit www.nsiindia.gov.in for latest instructions/ modification in the scheme.
! !130
4.11 Summary
The Department of Posts (DoP) has been touching the lives of Indian
citizens. By using technology to drive its business and align to the needs of
the consumers, the Department of Posts (DoP) has launched various
schemes meeting almost every needs of investors.
The Post Office Saving Schemes includes Post Office Savings Account, 5-
Year Post Office Recurring Deposit Account (RD), Post Office Time Deposit
Account (TD), Post Office Monthly Income Scheme Account (MIS), Senior
Citizen Savings Scheme (SCSS), 15 year Public Provident Fund Account
(PPF), National Savings Certificates (NSC), Kisan Vikas Patra (KVP),
Sukanya Samriddhi Accounts etc. The best part of these investment is
linking of interest rates to government bond yields
The Post Office Savings Account is meant for those who want to save
regularly as well as withdraw as and when they need money 5-Year Post
Office Recurring Deposit Account (RD) can be opened by those customers
who can save constant amount periodically for taking the lumpsum on
maturity to meet their financial goals.
The Post Office Time Deposit Account (TD) is preferred by those customers
who have lumpsum amount to deposit and want to make their money grow
for accomplishing life goals.
The Post Office Monthly Income Scheme Account (MIS) is preferred by

periodical returns in the form of interest earned on the deposit.
The Senior Citizen Savings Scheme (SCSS) is specially meant for

encouraging senior citizens with age of 60 years or more to invest and get
more interest rate.
The 15 year Public Provident Fund Account (PPF) is a long-term investment

and is debt scheme under Government of India on which the investor earns
regular interest.
The National Savings Certificates (NSC), popularly known as NSC, is like an

Indian Government Savings Bond, primarily used for small savings and
income tax saving investments
! !131
The Kisan Vikas Patra (KVP) is a saving certificate scheme available in the
denominations of Rs. 1000, Rs. 5000, Rs. 10000 and Rs 50000. The
minimum amount that can be invested is Rs. 1000. However, there is no
upper limit on the purchase of KVPs.
Sukanya Samriddhi Yojana is a small deposit scheme of the Government

of India meant exclusively for a girl child. The Sukanya Samriddhi Yojana is
as girl child prosperity scheme under Beti Bachao Beti padhao program of
the Prime Ministerof India. The scheme is meant to meet the education and
marriage expenses of a girl child.
1. Explain the different types of services provided by department of Post.
2. What are the salient features of a Post Office Savings Account?
3. What are the salient features of a 5-Year Post Office Recurring Deposit
Account (RD)?
4. What are the salient features of a Post Office Time Deposit Account
(TD)?
5. What are the salient features of a Post Office Monthly Income Scheme
Account (MIS)?
6. What are the salient features of a Senior Citizen Savings Scheme

(SCSS)?
7. What are the salient features of a 15 year Public Provident Fund

Account (PPF)?
8. What are the salient features of a National Savings Certificates (NSC)?
9. What are the salient features of a Kisan Vikas Patra (KVP) ?
10.What are the salient features of a Sukanya Samriddhi Yojana Account ?
! !132
1. Recurring deposit account can be opened by those customers who can

save constant amount periodically for taking the lumpsum on maturity
to meet their financial goals. The minimum amount for opening of 5-
Year Post Office Recurring Deposit Account (RD) is:
(a) Rs. 10
(b) Rs. 50
(c) Rs. 100
(d) Rs. 150
2. The Post Office Monthly Income Scheme Account (MIS) is preferred by

periodical returns in the form of interest earned on the deposit. The
maximum investment limit is:
(a) Rs. 3 lakhs
(b) Rs. 4.5 lakhs
(c) Rs. 10lakhs
(d) Rs. 15 lakhs
3. The National Savings Certificates (NSC), popularly known as NSC, is like

an Indian Government Savings Bond, primarily used for small savings
and income tax saving investments. The minimum amount for opening
the account is:
(a) Rs. 10
(b) Rs. 50
(c) Rs. 100
(d) Rs. 1000
4. The Kisan Vikas Patra (KVP) is a saving certificate scheme available in

the denominations of Rs. 1000, Rs. 5000, Rs. 10000 and Rs. 50000.
The minimum amount that can be invested is Rs. 1000. What is the
upper limit on the purchase of KVPs?
(a) Rs. 50000
(b) Rs. 100000
(c) Rs. 150000
(d) No upper limit
! !133
5. Sukanya Samriddhi Yojana is a small deposit scheme of the Government

of India meant exclusively for a girl child. The deposits made to the
account, and also the proceeds and maturity amount are fully exempt
from tax under section 80C of the Income Tax Act. State whether the
above statement is true or false.
(a) True
(b) False
Ans: 1 - (a), 2 - (b), 3 - (c), 4 - (d), 5 - (b)
4.13 References
1. https://www.indiapost.gov.in
2. https://en.wikipedia.org
3. What every Indian should know before investing by Vinod Pottayil
4. How to save income tax through tax planning by R N Lakhotia and

Subhash Lakhotia
5. In the wonderland of investment by A N Shanbhag and Sandeep

Shanbhag
! !134
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !135
COMPANY DEPOSITS NIDHIS AND CHITFUNDS
Chapter 5
Company Deposits Nidhis and Chitfunds
Objectives:
This chapter will help you understand basic objectives of deposits made
with different types of companies, Nidhis and Chit funds. It will also help
you understand the pros and cons of each type of deposit scheme.
Structure:
5.1 Introduction
5.2 Provisions of Companies Act 2013 for acceptance of deposits by

companies
5.3 RBI guidelines in acceptance of deposits by NBFCs
5.4 Acceptance of deposits by Housing Finance Companies
5.5 Nidhi companies
5.6 Chit Funds
5.7 Summary
5.9 References
! !136
5.1 Introduction
The Company deposits, Nidhis and Chit funds are the alternatives available
with the investors to save there money in expectation of varying returns.
Deposits from the public are an important mode of finance for

Companies to do their business. Public deposits refer to the unsecured
deposits invited by companies from the public mainly to finance working
capital needs. Company issues a receipt to acknowledge the debt after
receiving deposit from the public with the duly filled in application form
specifying terms and conditions. The terms and conditions of the deposit
are printed on the back of the receipt. The rate of interest depends upon
the period of deposit and varies from company to company based on their
strength. Companies prefer renewal of deposits inorder to use them as
medium term finance. Public deposits of a company cannot exceed 25 per
cent of its paid up capital, free reserves and securities premium account.
As these deposits are unsecured, the company having public deposits is
required to set aside 15 per cent of deposits maturing by the end of the
year. The amount so set aside can be used only for paying such deposits.
Companies incus less lost in inviting public deposits than taking bank loans
to finance their short term or medium term needs. Hence companies
attract the public to deposit money with them by offering a higher rate of
interest on public deposits than on bank deposits. There have been various
instances of default by companies in repaying deposits in the past. A wise
investor should look at various aspects of deposits, the applicable
regulations before investing his hard earned money in the lure of getting
higher returns.
A Nidhi company is incorporated with the object of developing the habit

of thrift and reserve funds amongst its members and also receiving
deposits and lending to its members only for their mutual benefit . Its core
business is borrowing and lending money between their members. They
are regulated by Ministry of Corporate Affairs. Reserve Bank of India is
empowered to issue directions to them in matters relating to their deposit
acceptance activities. Nidhi companies is governed by Nidhi Rules, 2014.
Since they are incorporated as a Public limited company they are also
required to comply with Companies Act, 2013. No RBI approval is
necessary to register the company, as RBI has specifically exempted this
category of NBFC in India. Nidhi Company registration is simple and less
complex as compared to other types of finance companies which require
! !137
RBI license. A Nidhi Company can get itself registered within 15-20 days. A
Nidhi Company can be started with an initial capital of Rs. 5 lakh and
require at least seven people and 3 Directors to start with.
Chit funds plays an important role in the financial development of people

by providing easier access to credit to the needy.
A chit fund is a type of rotating savings system practiced in India. Chit fund
schemes are formally organized by financial institutions, or informally
among friends, relatives, or neighbors. A chit fund can acts as a both a
borrowing scheme as well as a savings system.
With the advent of ecommerce in India, chit funds have also started going
online. Chit Funds may be misused by its promoters and hence investors
should remain alert on recent developments of Ponzi schemes. They should
not get lured by promises of extraordinary higher returns on their
investment in a short span of time.
Both organizers and subscribers in chit funds are exposed to credit risk.
Here again an investor must be cautious before investing to check the
credentials of the fund manager and the previous percentage of default
and the returns.
5.2 Provisions of Companies Act 2013 for acceptance of

deposits by companies
The provisions of Companies Act, 2013 and Companies (Acceptance of

Deposits) Rules, 2014 regulate various aspects of acceptance of deposits
from the public such as ceiling of total deposits, advertisement for seeking
deposits, acceptance and repayment of deposits by Companies.
What is a Deposit?
According to the definition given under section 2(31) of the Companies Act,
2013, read with Rule 2(c) of Companies (Acceptance of Deposits) Rules,
2014 the term ‘deposit’ includes any receipt of money by way of deposit or
loan or in any other form, by a company, but does not include such
categories of amount as may be prescribed in consultation with the RBI.
! !138
Deposits can be further classified into secured deposit and unsecured

deposit. Secured deposits are secured by creation of a charge on the
company assets for the due repayment of the amount of deposit and
interest thereon for an amount which shall not be less than the amount
remaining unsecured by the deposit insurance. Unsecured deposits does
not have any such backing.
Who is a Depositor?
‘Depositor’’ means,
1. any member of the company who has made a deposit with the company
in accordance with the provisions of sub-section (2) of section 73 of the
Act, or
2. any person who has made a deposit with a public company in

accordance with the provisions of section 76 of the Act.
Section 73 of Companies Act, 2013
1. No company shall invite, accept or renew deposits under this Act from
the public except in a manner provided under Chapter V of the
Companies Act, 2013 i.e Acceptance of Deposits by Companies.
2. A company may, subject to the passing of a resolution in general

meeting and subject to such rules as may be prescribed in consultation
with the Reserve Bank of India, accept deposits from its members on
such terms and conditions, including the provision of security, if any, or
for the repayment of such deposits with interest, as may be agreed
upon between the company and its members, subject to the fulfilment
of the following conditions, namely:
a. Issuance of a circular to its members including therein a statement

showing the financial position of the company, the credit rating
obtained, the total number of depositors and the amount due towards
deposits in respect of any previous deposits accepted by the company
and such other particulars in such form and in such manner as
prescribed under Rule 4 of Companies (Acceptance of deposits)
Rules, 2014.
! !139
b. Filing a copy of the circular along with such statement with the
Registrar within thirty days before the date of issue of the circular
c. Depositing on or before the 30th day of April each year, such sum
which shall not be less than 20% of the amount of its deposits
maturing during the following financial year and kept in a scheduled
bank in a separate bank account to be called as deposit repayment
reserve account
d. Certifying that the company has not committed any default in the
repayment of deposits accepted either before or after the
commencement of this Act or payment of interest on such deposits;
and
e. Providing security, if any for the due repayment of the amount of

deposit or the interest thereon including the creation of such charge
on the property or assets of the company. In case when a company
does not secure the deposits or secures such deposits partially, then,
the deposits shall be termed as ‘‘unsecured deposits’’ and shall be so
quoted in every circular, form, advertisement or in any document
related to invitation or acceptance of deposits.
3. Every deposit accepted by a company under sub-section (2) shall be

repaid with interest in accordance with the terms and conditions of the
agreement referred to in that sub-section.
4. Where a company fails to repay the deposit or part thereof or any

interest thereon under sub-section (3), the depositor concerned may
apply to the Tribunal for an order directing the company to pay the sum
due or for any loss or damage incurred by him as a result of such non-
payment and for such other orders as the Tribunal may deem fit.
5. The deposit repayment reserve account referred to in clause (c) of sub-

section (2) shall not be used by the company for any purpose other than
repayment of deposits.
! !140
Section 76 of Companies Act, 2013: Acceptance of Deposit from

Public by Eligible Companies
”Eligible company” means a public company having a :
• net worth of not less than one hundred crore rupees or
• a turnover of not less than five hundred crore rupees and
• complies with the requirements provided in sub-section (2) of section 73
• subject to such rules as the Central Government may in consultation with

the Reserve Bank of India prescribe
• has obtained rating (including its net-worth, liquidity and ability to pay its
deposits on due date) from a recognised credit rating agency for
informing the public the rating given to the company at the time of
invitation of deposits from the public which ensures adequate safety
• the rating shall be obtained for every year during the tenure of deposits.
• Every company accepting secured deposits from the public shall within
30 days of such acceptance, create a charge on its assets of an amount
not less than the amount of deposits accepted in favor of the deposit
holders
Acceptance of Deposits from the Public
Acceptance of Deposits
Public Company Private Company

!
! !141
According to section 73 of the Companies Act, 2013, no company shall

invite, accept or renew deposits from the public except in a manner
provided under Chapter V of i.e Acceptance of Deposits by Companies of
Companies Act, 2013.
However this Provision with Respect to the Acceptance or Renewal

of Deposit from Public will NOT Apply to
• (i) banking company
• (ii) non- banking financial company as defined in the Reserve Bank of

India Act, 1934
• a housing finance company registered with the National Housing Bank

established under the National Housing Bank Act, 1987, and
• and such other company as the Central Government may specify, after
consultation with the Reserve Bank of India
Minimum and Maximum Tenure for Acceptance of Deposits
According to Rule 3 of the Companies (Acceptance of Deposits) Rules,

2014, No company under section 73(2) and no eligible company shall
accept or renew any deposit, whether secured or unsecured, which is
repayable on demand or upon receiving a notice, within a period of less
than six months or more than thirty-six months from the date of
acceptance or renewal of such deposit.
However, a company may, for the purpose of meeting any of its short-
term requirements of funds, accept or renew such deposits for
repayment earlier than six months from the date of deposit or renewal, as
the case may be, subject to following conditions:
a. such deposits shall not exceed 10 per cent of the aggregate of the paid
up share capital, free reserves and securities premium account of the
company, and
b. such deposits are repayable not earlier than three months from the date
of such deposit or renewal thereof.
! !142
Maximum Acceptance Limit for Deposits
1. No company (except private company) referred to in section 73(2) shall

accept or renew any deposits from its Members, if the amount of such
deposits together with the amount of other deposits outstanding as on
the date of acceptance or renewal of such deposits exceeds 35% of the
aggregate of the paid-up share capital, free reserves and securities
premium account of the company.
A private company may accept from its members monies not

exceeding 100% of aggregate of the paid up share capital, free reserves
and securities premium account and such company shall file the details
of monies so accepted to the Registrar in such manner as may be
specified.
No Eligible Company Shall Accept or Renew
a. any deposit from its members, if the amount of such deposit together
with the amount of deposits outstanding as on the date of acceptance or
renewal of such deposits from members exceeds ten per cent. of the
aggregate of the Paid-up share capital, free Reserves and securities
premium account of the company;
b. any other deposit, if the amount of such deposit together with the
amount of such other deposits, other than the deposit referred to in
clause (a), outstanding on the date of acceptance or renewal exceeds
twenty-five per cent. of aggregate of the Paid-up share capital, free
Reserves and securities premium account of the company.
No Government company eligible to accept deposits under section 76

shall accept or renew any deposit, if the amount of such deposits together
with the amount of other deposits outstanding as on the date of
acceptance or renewal exceeds thirty five per cent. of the aggregate of its
Paid-up share capital, free Reserves and securities premium account of the
company.
! !143
Deposits may be Accepted in Joint Names
Deposits may be accepted in joint names not exceeding three, with or

without any of the clauses, namely, “Jointly”, “Either or Survivor”, “First
named or Survivor”, “Anyone or Survivor”.
Rate of Interest and Brokerage
No company under section 73(2) or any Eligible company shall invite or

accept or renew any deposits in any form, carrying a rate of interest or pay
brokerage thereon at a rate exceeding the maximum rate of interest or
brokerage prescribed by the Reserve Bank of India for acceptance of
deposits by non-banking financial companies. [Rule 3(6)]
Only the person who is authorized, in writing, by a company to solicit

deposits on its behalf and through whom deposits are actually procured will
be entitled to the brokerage and payment of brokerage to any other person
for procuring deposits shall be deemed to be in violation of these Rules.
Alteration of Terms and Conditions
The Company shall not reserve to itself either directly or indirectly a right
to alter, to the prejudice or disadvantage of the depositor, any of the terms
and conditions of the deposit, deposit trust deed and deposit insurance
contract after circular or circular in the form of advertisement is issued and
deposits are accepted. [Rule 3(7)]
Credit Rating
Every eligible company shall obtain, at least once in a year, credit rating for
deposits accepted by it and a copy of the rating shall be sent to the
Registrar of Companies along with the return of deposits in Form DPT-3.
The credit rating shall not be below the minimum investment grade rating
or other specified credit rating for fixed deposits, from any one of the
approved credit rating agencies as specified for Non-Banking Financial
Companies in the Non-Banking Financial Companies Acceptance of Public
Deposits (Reserve Bank) Directions, 1998, issued by the Reserve Bank of
India, as amended from time to time. [Rule 3(8)]
! !144
Various Credit Rating Agencies

(a) The Credit Rating lnformation Services of lndia Ltd
(b) ICRA Ltd.
(c) Credit Analysis and Research Ltd
(d) Fitch Ratings lndia Private Ltd
(e) Brickwork Ratings India Pvt Ltd (Brickwork)
(f) SME Rating Agency of India Ltd.
Issue of Advertisements or Circulars for inviting deposit [Rule 4]
1. Every company referred in section 73(2) (except Private company) or

any Eligible company intending to invite deposit from its members shall
issue a circular to all its members by registered post with
acknowledgement due or speed post or by electronic mode in Form
DPT-1. [Rule 4(1)]
2. In addition to issue of such circular to all members, the circular may be

published in English language in an English newspaper and in vernacular
language in a vernacular newspaper having wide circulation in the State
in which the registered office of the company is situated. [Rule 4(1)]
3. Every eligible company intending to invite deposits shall issue a circular

in the form of an advertisement in Form DPT-1 for the purpose in
English language in an English newspaper having wide circulation and in
vernacular language in a vernacular newspaper having wide circulation
in the State in which the registered office of the company is situated
and shall also place such circular on the website of the company, if any.
[Rule 4(2)]
4. Every company inviting deposits from the public shall upload a copy of
the circular on itswebsite, if any. [Rule 4(3)
Who shall Issue circular for Inviting Deposit?
A circular or circular in the form of advertisement inviting deposits shall be

issued on the authority and in the name of the Board of directors of the
company. [Rule 4(4)].
! !145
Registration of Copy of Circular with the Registrar
A copy of circular or a circular in the form of advertisement signed by a

majority of the directors of the company at the time the Board approved
the circular or circular in the form of advertisement, or their agents, duly
authorised by them in writing shall be delivered to the Registrar for
registration at least thirty days prior to issue of such circular. [Rule 4(5)].
What will be the Validity of the Circular?
A circular or circular in the form of advertisement issued shall be valid:
• until the expiry of 6 months from the date of closure of the financial year
in which it is issued or
• until the date on which the financial statement is laid before the company
in annual general meeting or,
• where the annual general meeting for any year has not been held, the
latest day on which that meeting should have been held in accordance
with the provisions of the Act, whichever is earlier, and a fresh circular or
circular in the form of advertisement shall be issued, in each succeeding
financial year, for inviting deposits during that financial year. [Rule 4(6)]
What will be Issue Date and Effective Date?
The date of the issue of the newspaper in which the advertisement appears
shall be taken as the date of issue of the advertisement and the effective
date of issue of circular shall be the date of dispatch of the circular.
Creation of Security [Rule 6]
Every company referred to in sub-section (2) of section 73 and every

eligible company inviting secured deposits shall provide for security by way
of a charge on its assets as referred to in Schedule III of the Act excluding
intangible assets of the company for the due repayment of the amount of
deposit and interest thereon for an amount which shall not be less than the
amount remaining unsecured by the deposit insurance.
! !146
In the case of deposits which are secured by the charge on the assets
referred to in Schedule III of the Act excluding intangible assets, the
amount of such deposits and the interest payable thereon shall not exceed
the market value of such assets as assessed by a registered valuer.
The total value of the security either by way of deposit insurance or by way
of charge or by both shall not be less than the amount of deposits accepted
and the interest payable thereon.
Valuation of stocks, shares, debentures, securities etc. shall be conducted

by an independent merchant banker who is registered with the SEBI or an
independent chartered accountant in practice having a minimum
experience of ten years.
The security (not being in the nature of a pledge) for deposits as specified
in sub-rule (1) shall be created in favour of a trustee for the depositors on:
a. specific movable property of the company, or
b. specific immovable property of the company wherever situated, or

any interest therein.
Appointment of Trustee for Depositors
Every company referred to in section 73(2) and every eligible company

inviting secured deposits before issue a circular or advertisement appoint
one or more deposit trustees for depositors for creating security for the
deposits. [Rule 7(1)]
A Written Consent from Trustees
A written consent shall be obtained from the trustee for depositors before
their appointment and a statement shall appear in the circular or circular in
the form of advertisement with reasonable prominence to the effect that
the trustee for depositors has given their consent to the company to be so
appointed. [Rule 7(1)].
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Execution of Trust Deed
The Company shall execute a deposit trust deed in Form No. DPT-2 at least
7 days before issuing the circular or circular in the form of advertisement.
[Rule 7(2)].
Prohibition on Appointing Certain Persons as Trustees
No person including a company that is in the business of providing

trusteeship services shall be appointed as a trustee for the deposit holders,
if the proposed trustee -
a. is a director, key managerial personnel or any other officer or an

employee of the company or of its holding, subsidiary or associate
company or a depositor in the company;
b. is indebted to the company, or its subsidiary or its holding or

associate company or a subsidiary of such holding company
c. has any material pecuniary relationship with the company
d. has entered into any guarantee arrangement in respect of principal

debts secured by the deposits or interest thereon
e. is related to any person specified in clause (a) above. [Rule 7(3)]
Consent of all Directors Required for Removal of Trustees
No trustee for depositors shall be removed from office after the issue of
circular or advertisement and before the expiry of his term except with the
consent of all the directors present at a meeting of the board. In case the
company is required to appoint independent directors, at least one
independent director shall be present in such meeting of the Board. [Rule
7(4)].
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Duties of Deposit Trustees: It Shall be the Duty of Every Deposit

Trustee to
a. ensure that the assets of the company on which charge is created

together with the amount of deposit insurance are sufficient to cover the
repayment of the principal amount of secured deposits outstanding and
interest accrued thereon;
b. satisfy himself that the circular or advertisement inviting deposits does

not contain any information which is inconsistent with the terms of the
deposit scheme or with the trust deed andis in compliance with the rules
and provisions of the Act;
c. ensure that the company does not commit any breach of covenants and
provisions of the trust deed;
d. take such reasonable steps as may be necessary to procure a remedy

for any breach of covenants of the trust deed or the terms of invitation
of deposits;
e. take steps to call a meeting of the holders of depositors as and when

such meeting is required to be held;
f. supervise the implementation of the conditions regarding creation of

security for deposits and the terms of deposit insurance;
g. do such acts as are necessary in the event the security becomes

enforceable;
h. carry out such acts as are necessary for the protection of the interest of
depositors and to resolve their grievances. [Rule 8].
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Deposit Trustee should Call Meeting of Depositors
The meeting of all the depositors shall be called by the deposit trustee on-
a. requisition in writing signed by at least one-tenth of the depositors in

value for the time being outstanding;
b. the happening of any event, which constitutes a default or which in the

opinion of the deposit trustee affects the interest of the depositors.
[Rule 9].
Application for Deposits by Depositors
Every company shall accept, or renew any deposit, whether secured or

unsecured, only if an application containing a declaration by the intending
depositor to the effect that the deposit is not being made out of any money
borrowed by him from any other person, is submitted by the intending
depositor for the acceptance of such deposit. [Rule 10].
Nomination by Depositors
A depositor may, at any time, nominate any person to whom his deposits
shall vest in the event of his death and the provisions of section 72 shall,
as far as may be, apply to the nomination made under this Rule [Rule 11].
Deposit Receipts
Every company shall, on the acceptance or renewal of a deposit, furnish to

the depositor or his agent a deposit receipt for the amount received by the
company, within a period of 21 days from the date of receipt of money or
realisation of cheques. [Rule 12(1)]
Signature on Deposit Receipt
Deposit receipt shall be signed by an officer of the company duly

authorized by the Board in this behalf and shall state the date of deposit,
the name and address of the depositor, the amount received by the
company as deposit, the rate and periodicity of interest payable thereon
and the date on which the deposit is repayable. [Rule 12(2)].
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Repayment of Deposit
Every deposit accepted by a company shall be repaid with interest in

accordance with the terms and conditions of the agreement. [Section
73(3)].
If the Company Fails to Repay Deposit
When a company fails to repay the deposit or part thereof or any interest
thereon under sub-section (3), the depositor concerned may apply to the
Tribunal/CLB for an order directing the company to pay the sum due or for
any loss or damage incurred by him as a result of such non-payment and
for such other orders as the Tribunal/CLB may deem fit. [Section 73(4)].
What I to be Done for Premature Repayment of Deposits?
When a company makes a repayment of deposits, on the request of the

depositor, after the expiry of a period of six months from the date of such
deposit but before the expiry of the period for which such deposit was
accepted, the rate of interest payable on such deposit shall be reduced by
one per cent. from the rate which the company would have paid had the
deposit been accepted for the period for which such deposit had actually
run and the company shall not pay interest at any rate higher than the rate
so reduced. [Rule 15].
Renewal for Availing of a Higher Rate of Interest
When a company referred to in under section 73(2) or any eligible

company permits a depositor to renew his deposit, before the expiry of the
period for which such deposit was accepted by the company, for availing of
a higher rate of interest, the company shall pay interest to such depositor
at the higher rate if such deposit is renewed in accordance with the other
provisions of these rules and for a period longer than the unexpired period
of the deposit. For the purposes of this rule, where the period for which the
deposit had run contains any part of a year, then, if such part is less than
six months, it shall be excluded and if such part is six months or more, it
shall be reckoned as one year. [Second Proviso to Rule 15].
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Registers of Deposits [Rule 14]
1. Every company accepting deposits shall maintain at its registered office

one or more separate registers for deposits accepted or renewed, in
which there shall be entered separately in the case of each depositor the
following particulars, namely:
a. name, address and PAN of the depositor/s;

b. particulars of guardian, in case of a minor;
c. particulars of the nominee;
d. deposit receipt number;
e. date and the amount of each deposit;
f. duration of the deposit and the date on which each deposit is
repayable;
g. rate of interest or such deposits to be payable to the depositor;
h. due date for payment of interest;
i. mandate and instructions for payment of interest and for non-
deduction of tax at source, if any;
j. date or dates on which the payment of interest shall be made;
k. details of deposit insurance including extent of deposit insurance;
l. particulars of security or charge created for repayment of deposits;
m. any other relevant particulars;
2. The entries specified in sub-rule (1) shall be made within seven days
from the date of issuance of the receipt duly authenticated by a director
or secretary of the company or by any other officer authorised by the
Board for this purpose.
3. The register referred to in sub-rule (1) shall be preserved in good order

for a period of not less than eight years from the financial year in
which the latest entry is made in the register.
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Return of Deposits to be Filed with the Registrar [Rule 16]
Every company to which these rules apply, shall on or before the 30th day
of June, of every year, file with the Registrar, a return in Form DPT-3 along
with the fee as provided in Companies (Registration Offices and Fees)
Rules, 2014 and furnish the information contained therein as on the 31st
day of March of that year duly audited by the auditor of the company.
Disclosures in the Financial Statement [Rule 16A]
1. Every company, other than a private company, shall disclose in its

financial statement by way of notes, about the money received from the
director.
2. Every private company shall disclose in its financial statement by way of

notes, about the money received from the directors, or relatives of
directors.
Penal Rate of Interest [Rule 17]
Every company shall pay a penal rate of interest of 18% per annum for the
overdue period in case of deposits, whether secured or unsecured, matured
and claimed but remaining unpaid.
Punishment for Contravention
1. Where a company accepts or invites or allows or causes any other

person to accept or invite on its behalf any deposit in contravention of
the manner or the conditions prescribed under section 73 or section 76
or rules made thereunder or if a company fails to repay the deposit or
part thereof or any interest due thereon within the time specified under
section 73 or section 76 or rules made thereunder or such further time
as may be allowed by the Tribunal/CLB under section 73,-
a. the company shall, in addition to the payment of the amount of

deposit or part thereof and the interest due, be punishable with fine
which shall not be less than 1 crore rupees but which may extend to
10 crore rupees; and
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b. every officer of the company who is in default shall be punishable

with imprisonment which may extend to 7 years or with fine which
shall not be less than 25 lakh rupees but which may extend to 2
crore rupees, or with both:
c. If it is proved that the officer of the company, who is in default, has

contravened such provisions knowingly or wilfully with the intention
to deceive the company or its shareholders or depositors or creditors
or tax authorities, he shall be liable for action under section 447.
2. If any company contravenes any provisions of Companies (Acceptance

of Deposit) Rules, 2014 for which no punishment is provided in the Act,
then the company and every officer in default shall be punishable with
fine which may extend to Rs. 5000 and in case contravention is
continuing one, with a further fine which may extend upto Rs. 500 per
day for every day after the first day during which the default continues.
[Rule 21].
Remedy under Section 245(1)(g)
Requisite number of depositor or depositors may, if they are of the opinion

that the management or conduct of the affairs of the company are being
conducted in a manner prejudicial to the interests of the company or its
members or depositors, file an application before the Tribunal on behalf of
the depositors for seeking orders including claiming damages or
compensation or demand any other suitable action from or against—
• the company or its directors for any fraudulent, unlawful or wrongful act
or omission or conduct or any likely act or omission or conduct on its or
their part;
• the auditor including audit firm of the company for any improper or
misleading statement of particulars made in his audit report or for any
fraudulent, unlawful or wrongful act or conduct; or
• any expert or advisor or consultant or any other person for any incorrect
or misleading statement made to the company or for any fraudulent,
unlawful or wrongful act or conduct or any likely act or conduct on his
part;
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• to seek any other remedy as the Tribunal may deem fit.
Section 245(2) states that when the depositors seek any damages or
compensation or demand any other suitable action from or against an audit
firm, the liability shall be of the firm as well as of each partner who was
involved in making any improper or misleading statement of particulars in
the audit report or who acted in a fraudulent, unlawful or wrongful manner.
Section 245(3) (ii) states that the requisite number of depositors

provided in sub-section (1) shall not be less than one hundred depositors
or not less than such percentage of the total number of depositors as may
be prescribed, whichever is less, or any depositor or depositors to whom
the company owes such percentage of total deposits of the company as
may be prescribed.
5.3 RBI guidelines in acceptance of deposits by NBFCs
The FAQs (selected portions with Company’s Act 2013 updations) on All
you wanted to know about NBFCs by RBI https://www.rbi.org.in/
commonman/english/scripts/FAQs.aspx?Id=1167.
A Non-Banking Financial Company (NBFC) is a company registered under

the Companies Act, 2013 engaged in the business of loans and advances,
acquisition of shares/stocks/bonds/debentures/securities issued by
Government or local authority or other marketable securities of a like
nature, leasing, hire-purchase, insurance business, chit business but does
not include any institution whose principal business is that of agriculture
activity, industrial activity, purchase or sale of any goods (other than
securities) or providing any services and sale/purchase/construction of
immovable property. A non-banking institution which is a company
and has principal business of receiving deposits under any scheme
or arrangement in one lump sum or in installments by way of
contributions or in any other manner, is also a non-banking
financial company (Residuary non-banking company).
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What does Conducting Financial Activity as “Principal Business”

Mean?
Financial activity as principal business is when a company’s financial assets

constitute more than 50 per cent of the total assets and income from
financial assets constitute more than 50 per cent of the gross income. A
company which fulfils both these criteria will be registered as NBFC by RBI.
The term 'principal business' is not defined by the Reserve Bank of India
Act. The Reserve Bank has defined it so as to ensure that only companies
predominantly engaged in financial activity get registered with it and are
regulated and supervised by it. Hence if there are companies engaged in
agricultural operations, industrial activity, purchase and sale of goods,
providing services or purchase, sale or construction of immovable property
as their principal business and are doing some financial business in a small
way, they will not be regulated by the Reserve Bank. Interestingly, this test
is popularly known as 50-50 test and is applied to determine whether or
not a company is into financial business.
NBFCs are Doing Functions Similar to Banks. What is Difference

Between Banks & NBFCs?
NBFCs lend and make investments and hence their activities are akin to
that of banks; however there are a few differences as given below:
1. NBFC cannot accept demand deposits;
2. NBFCs do not form part of the payment and settlement system and
cannot issue cheques drawn on itself;
3. deposit insurance facility of Deposit Insurance and Credit Guarantee

Corporation is not available to depositors of NBFCs, unlike in case of
banks.
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Is it Necessary that Every NBFC Should be Registered With RBI?
In terms of Section 45-IA of the RBI Act, 1934, no Non-banking Financial

company can commence or carry on business of a non-banking financial
institution without (a) obtaining a certificate of registration from the Bank
and without having a Net Owned Funds of Rs. 25 lakhs (Rs. Two crore since
April 1999). However, in terms of the powers given to the Bank, to obviate
dual regulation, certain categories of NBFCs which are regulated by other
regulators are exempted from the requirement of registration with RBI viz.
Venture Capital Fund/Merchant Banking companies/Stock broking
companies registered with SEBI, Insurance Company holding a valid
Certificate of Registration issued by IRDA, Nidhi companies as notified
under the Companies Act, 2013, Chit companies as defined in clause (b) of
Section 2 of the Chit Funds Act, 1982,Housing Finance Companies
regulated by National Housing Bank, Stock Exchange or a Mutual Benefit
company.
What are the Requirements for Registration with RBI?
A company incorporated under the Companies Act, 2013 and desirous of

commencing business of non-banking financial institution as defined under
Section 45I(a) of the RBI Act, 1934 should comply with the following:
1. it should be a company registered under the companies Act, 2013
2. It should have a minimum net owned fund of Rs. 200 lakh.
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What is ‘Deposit’ and ‘Public Deposit’? Is it Defined Anywhere?
The term ‘deposit’ is defined under Section 45 I(bb) of the RBI Act, 1934.
‘Deposit’ includes and shall be deemed always to have included any receipt
of money by way of deposit or loan or in any other form but does not
include:
1. amount raised by way of share capital, or contributed as capital by

partners of a firm;
2. amount received from a scheduled bank, a co-operative bank, a banking

company, Development bank, State Financial Corporation, IDBI or any
other institution specified by RBI;
3. amount received in ordinary course of business by way of security

deposit, dealership deposit, earnest money, advance against orders for
goods, properties or services;
4. amount received by a registered money lender other than a body

corporate;
5. amount received by way of subscriptions in respect of a ‘Chit’.
Paragraph 2(1)(xii) of the Non-Banking Financial Companies Acceptance of

Public Deposits ( Reserve Bank) Directions, 1998 defines a ‘ public deposit’
as a ‘deposit’ as defined under Section 45 I(bb) of the RBI Act, 1934.
Which Entities can Legally Accept Deposits from Public?
Banks, including co-operative banks, can accept deposits. Non-bank

finance companies, which have been issued Certificate of Registration by
RBI with a specific licence to accept deposits, are entitled to accept public
deposit. In other words, not all NBFCs registered with the Reserve Bank
are entitled to accept deposits but only those that hold a deposit accepting
Certificate of Registration can accept deposits. They can, however, accept
deposits, only to the extent permissible. Housing Finance Companies,
which are again specifically authorized to collect deposits and companies
authorized by Ministry of Corporate Affairs under the Companies
Acceptance of Deposits Rules framed by Central Government under the
Companies Act can also accept deposits also upto a certain limit.
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Cooperative Credit Societies can accept deposits from their members but
not from the general public. The Reserve Bank regulates the deposit
acceptance only of banks, cooperative banks and NBFCs.
It is not legally permissible for other entities to accept public deposits.

Unincorporated bodies like individuals, partnership firms, and other
association of individuals are prohibited from carrying on the business of
acceptance of deposits as their principal business. Such unincorporated
bodies are prohibited from even accepting deposits if they are carrying on
financial business.
Can all NBFCs Accept Deposits? Is there any Ceiling on Acceptance

of Public Deposits? What is the Rate of Interest and Period of
Deposit which NBFCs can Accept?
All NBFCs are not entitled to accept public deposits. Only those NBFCs to
which the Bank had given a specific authorisation and have an investment
grade rating are allowed to accept/hold public deposits to a limit of 1.5
times of its Net Owned Funds.
The maximum rate of interest an NBFC can offer is 12.5%. The interest
may be paid or compounded at rests not shorter than monthly rests. The
NBFCs are allowed to accept/renew public deposits for a minimum period
of 12 months and maximum period of 60 months. They cannot accept
deposits repayable on demand.
In Respect of Companies which do not Fulfill the 50-50 Criteria but

are Accepting Deposits – do they Come under RBI Purview?
A company which does not have financial assets which is more than 50%
of its total assets and does not derive at least 50% of its gross income
from such assets is not an NBFC. Its principal business would be non-
financial activity like agricultural operations, industrial activity, purchase or
sale of goods or purchase/construction of immoveable property, and will be
a non-banking non-financial company. Acceptance of deposits by a Non-
Banking Non-Financial Company are governed by the rules and regulations
issued by the Ministry of Corporate Affairs.
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Why is the RBI so Restrictive in Allowing NBFCs to Raise Public

Deposits?
The Reserve Bank's overarching concern while supervising any financial

entity is protection of depositors' interest. Depositors place deposit with
any entity on trust unlike an investor who invests in the shares of a
company with the intention of sharing the risk as well as return with the
promoters. Protection of depositors' interest thus is supreme in financial
regulation. Banks are the most regulated financial entities. The Deposit
Insurance and Credit Guarantee Corporation pays insurance on deposits up
to Rs. One lakh in case a bank failed.
Which are the NBFCs Specifically Authorized by RBI to Accept

Deposits?
The Reserve Bank publishes the list of NBFCs that hold a valid Certificate of
Registration for accepting deposits on its website: www.rbi.org.in →
Sitemap → NBFC List → List of NBFCs Permitted to Accept Deposits. At
times, some companies are temporarily prohibited from accepting public
deposits. The Reserve Bank publishes the list of NBFCs temporarily
prohibited also on its website. The Reserve Bank keeps both these lists
updated. Members of the public are advised to check both these lists
before placing deposits with NBFCs.
Whether NBFCs can Accept Deposits from NRIs?
Effective from April 24, 2004, NBFCs cannot accept deposits from NRIs
except deposits by debit to NRO account of NRI provided such amount
does not represent inward remittance or transfer from NRE/FCNR (B)
account. However, the existing NRI deposits can be renewed.
Can a Co-operative Credit Society Accept Deposits from the Public?
No. Co-operative Credit Societies cannot accept deposits from general

public. They can accept deposits only from their members within the limit
specified in their bye laws.
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Can a Salary Earners’ Society Accept Deposits from the Public?
No. These societies are formed for salaried employees and hence they can
accept deposit only from their own members and not from general public.
Can Proprietorship/Partnership Concerns Associated/Not

Associated with Registered NBFCs Accept Public Deposits?
No. Proprietorship and partnership concerns are un-incorporated bodies.

Hence they are prohibited under the RBI Act 1934 from accepting public
deposits.
Are Collective Investment Schemes (CIS) regulated by the Reserve

Bank of India?
No. CIS are schemes where money is exchanged for units, be it time share
in resorts, profit from sale of wood or profits from the developed
commercial plots and buildings and so on. Collective Investment Schemes
(CIS) do not fall under the regulatory purview of the Reserve Bank.
Which is the Authority that Regulates Collective Investment

Schemes (CIS)?
SEBI is the regulator of CIS. Information on such schemes and grievances

against the promoters may be immediately forwarded to SEBI as well as to
the EOW/Police Department of the State Government.
Is the Conducting of Chit Fund Business Permissible under Law?
The chit funds are governed by Chit Funds Act, 1982 which is a Central Act
administered by state governments. Those chit funds which are registered
under this Act can legally carry on chit fund business.
If Chit Fund Companies are Financial Entities, why are they not
Regulated by RBI?
Chit Fund companies are regulated under the Chit Fund Act, 1982, which is
a Central Act, and is implemented by the State Governments. RBI has
prohibited chit fund companies from accepting deposits from the public in
! !161
2009. In case any Chit Fund is accepting public deposits, RBI can
prosecute such chit funds
What are Money Circulation/Ponzi/Multi-level Marketing Schemes?
Money circulation, multi level marketing/Chain Marketing or Ponzi schemes

are schemes promising easy or quick money upon enrollment of members.
Income under Multi level marketing or pyramid structured schemes do not
come from the sale of products they offer as much as from enrolling more
and more members from whom hefty subscription fees are taken. It is
incumbent upon all members to enroll more members, as a portion of the
subscription amounts so collected are distributed among the members at
the top of the pyramid. Any break in the chain leads to the collapse of the
pyramid, and the members lower in the pyramid are the ones that are
affected the most. Ponzi schemes are those schemes that collect money
from the public on promises of high returns. As there is no asset creation,
money collected from one depositor is paid as returns to the other. Since
there is no other activity generating returns, the scheme becomes unviable
and impossible for the people running the scheme to meet the promised
return or even return the principal amounts collected. The scheme
inevitably fails and the perpetrators disappear with the money.
Is Acceptance of Money under Money Circulation/Multi-level

Marketing/Pyramid Structured Schemes Allowed? Does RBI
Regulates such schemes?
No. Acceptance of money under Money Circulation/Multi-level Marketing/

Pyramid structured schemes and Ponzi schemes is not allowed as
acceptance of money under those schemes is a cognizable offence under
the Prize Chit and Money Circulation (Banning) Act 1978 and are hence
banned. The Reserve Bank has no role in implementation of this Act,
except advising and assisting the Central Government in framing the Rules
under this Act.
Then who Regulates Entities that run Such Schemes?
Money Circulation/Multi-level Marketing/Pyramid structured schemes are

an offence under the Prize Chits and Money Circulation Schemes (Banning)
Act, 1978. The Act prohibits any person or individual to promote or conduct
any prize chit or money circulation scheme or enrol as member to its
! !162
schemes or anyone to participate in it by either receiving or remitting any

money in pursuance of such chit or scheme. Contravention of the
provisions of this Act, is monitored and dealt with by the State
Governments.
There are some Companies like Multi-Level Marketing Companies,

Direct Selling Companies, Online Selling Companies. Do they come
under the purview of RBI?
No, Multi-Level Marketing companies, Direct Selling Companies, Online

Selling Companies do not fall under the purview of RBI. Activities of these
companies fall under the regulatory/administrative domain of respective
state government. The list of regulators and the entities regulated by them
are as provided in Annex I.
What if Someone Operates such a Scheme?
Any information/grievance relating to such schemes should be given to the

police / Economic Offence Wing (EOW) of the concerned State Government
or the Ministry of Corporate Affairs. If brought to RBI notice – we will
inform the same to the concerned State Government authorities.
What are Unincorporated Bodies (UIBs)? Has RBI any Role to Play
in Curbing Illegal Deposit Acceptance Activities of UIBs? Who has
the Power to Take Action Against Unincorporated Bodies (UIBs)
Accepting Deposits?
Unincorporated bodies (UIBs) include an individual, a firm or an

unincorporated association of individuals. In terms of provision of section
45S of RBI act, these entities are prohibited from accepting any deposit.
The Act makes acceptance of deposits by such UIBs punishable with
imprisonment or fine or both. The State government has to play a
proactive role in arresting the illegal activities of such entities to protect
interests of depositors/investors.
UIBs do not come under the regulatory domain of RBI. Whenever RBI
receives any complaints against UIBs, it immediately forwards the same to
the state government police agencies (Economic Offences Wing (EOW)).
The complainants are advised to lodge the complaints directly with the
! !163
State government police authorities (EOW) so that appropriate action

against the culprits is taken immediately and the process is hastened.
There are some Entities (Not Companies) which Carry on Activities

like that of NBFCs. Are they Allowed to take Deposits? Who
Regulates them?
Any person who is an individual or a firm or unincorporated association of

individuals cannot accept deposits except by way of loan from relatives, if
his/its business wholly or partly includes loan, investment, hire-purchase or
leasing activity or principal business is that of receiving of deposits under
any scheme or arrangement or in any manner or lending in any manner.
As per Section 45T of RBI Act, both the RBI and State Governments have
been given concurrent powers. Nonetheless, in order to take immediate
action against the offender, the information should immediately be passed
on to the State Police or the Economic Offences Wing of the concerned
State who can take prompt and appropriate action. Since the State
Government machinery is widespread and the State Government is also
empowered to take action under the provisions of RBI Act, 1934, any
information on such entities accepting deposits may be provided
immediately to the respective State Government’s Police Department/EOW.
Many of the State Governments have enacted the State Protection of

Interests of Depositors in Financial Establishments Act, which empowers
the State Government to take appropriate and timely action.
RBI on its part has taken various steps to curb activities of UIBs which
includes spreading awareness through advertisements in leading
newspapers to sensitise public, organize various investors awareness
programmes in various districts of the country, keeps close liaison with the
law enforcing agencies (Economic Offences Wing).
What precautions have to be taken by the public to forewarn

themselves about the likelihood of losing money in schemes that
offer high rates of interest?
Before investing in schemes that promise high rates of return investors

must ensure that the entity offering such returns is registered with one of
the financial sector regulators and is authorized to accept funds, whether in
! !164
the form of deposits or otherwise. Investors must generally be circumspect

if the interest rates or rates of return on investments offered are high.
Unless the entity accepting funds is able to earn more than what it
promises, the entity will not be able to repay the investor as promised. For
earning higher returns, the entity will have to take higher risks on the
investments it makes. Higher the risk, the more speculative are its
investments on which there can be no assured return. As such, the public
should forewarn themselves that the likelihood of losing money in schemes
that offer high rates of interest are more.
Who can the Depositor/Investor turn to in Case of Grievances?
The two Charts given at Annex I and II depict the activities and the
regulators overseeing the same. Complaints may hence be addressed to
the concerned regulator. If the activity is a banned activity, the aggrieved
person can approach the State Police/Economic Offences Wing of the State
Police and lodge a suitable complaint.
Is Nomination Facility available to the Depositors of NBFCs?
Yes, nomination facility is available to the depositors of NBFCs. The Rules

for nomination facility are provided for in section 45QB of the Reserve Bank
of India Act, 1934. Non-Banking Financial Companies have been advised to
adopt the Banking Companies (Nomination) Rules, 1985 made under
Section 45ZA of the Banking Regulation Act, 1949.
There are Many Jewellery shops taking Money from the public in
Instalments. Is this Amounting to Acceptance of Deposits?
It depends on whether the money is received as advance for delivering

jewellery at a future date or whether the money is received with a promise
to return the same with interest. The money accepted by Jewellery shops
in instalments for the purpose of delivering jewellery at the end of the
period of contract is not deposit. It will amount to acceptance of deposits if
in return for the money received, the jewellery shop promises to return the
principal amount along with interest.
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What Action can be taken if such Unincorporated Entities Accept

Public Deposits? What if NBFCs which have not been authorized to
Accept Public Deposits use Proprietorship/Partnership firms
Floated by their Promoters to Collect Deposits?
Such unincorporated entities, if found accepting public deposits, are liable

for criminal action. Further NBFCs are prohibited by RBI from associating
with any unincorporated bodies. If NBFCs associate themselves with
proprietorship/partnership firms accepting deposits in contravention of RBI
Act, they are also liable to be prosecuted under criminal law or under the
Protection of Interest of Depositors (in Financial Establishments) Act, if
passed by the State Governments.
What is the Difference Between Acceptance of Money by Chit Funds

and Acceptance of Deposits?
Deposits are defined under the RBI Act 1934 as acceptance of money other
than that raised by way of share capital, money received from banks and
other financial institutions, money received as security deposit, earnest
money and advance against goods or services and subscriptions to chits.
All other amounts, received as loan or in any form are treated as deposits.
Chit Funds activity involves contributions by members in instalments by
way of subscription to the Chit and by rotation each member of the Chit
receives the chit amount. The subscriptions are specifically excluded from
the definition of deposits and cannot be termed as deposits. While Chit
funds may collect subscriptions as above, they are prohibited by RBI from
accepting deposits with effect from August 2009.
What are the Salient Features of NBFC Regulations which the

Depositor may note at the Time of Investment?
Some of the important regulations relating to acceptance of deposits by

NBFCs are as under:
The NBFCs are allowed to accept/renew public deposits for a minimum

period of 12 months and maximum period of 60 months. They cannot
accept deposits repayable on demand.
NBFCs cannot offer interest rates higher than the ceiling rate prescribed by
RBI from time to time. The present ceiling is 12.5 per cent per annum. The
! !166
interest may be paid or compounded at rests not shorter than monthly

rests.
NBFCs cannot offer gifts/incentives or any other additional benefit to the

depositors.
NBFCs should have minimum investment grade credit rating.
The deposits with NBFCs are not insured.
The repayment of deposits by NBFCs is not guaranteed by RBI.
Certain mandatory disclosures are to be made about the company in the

Application Form issued by the company soliciting deposits.
What Precautions should a Depositor take before Placing Deposit

with an NBFC?
A depositor wanting to place deposit with an NBFC must take the following
precautions before placing deposits:
That the NBFC is registered with RBI and specifically authorized by the RBI
to accept deposits. A list of deposit taking NBFCs entitled to accept
deposits is available at www.rbi.org.in → Sitemap → NBFC List. The
depositor should check the list of NBFCs permitted to accept public
deposits and also check that it is not appearing in the list of companies
prohibited from accepting deposits, which is available at www.rbi.org.in →
Sitemap → NBFC List → NBFCs who have been issued prohibitory orders,
winding up petitions filed and legal cases under Chapter IIIB, IIIC and
others.
NBFCs have to prominently display the Certificate of Registration (CoR)

issued by the Reserve Bank on its site. This certificate should also reflect
that the NBFC has been specifically authorized by RBI to accept deposits.
Depositors must scrutinize the certificate to ensure that the NBFC is
authorized to accept deposits.
The maximum interest rate that an NBFC can pay to a depositor should not
exceed 12.5%. The Reserve Bank keeps altering the interest rates
depending on the macro-economic environment. The Reserve Bank
! !167
publishes the change in the interest rates on www.rbi.org.in → Sitemap →

NBFC List → FAQs.
The depositor must insist on a proper receipt for every amount of deposit
placed with the company. The receipt should be duly signed by an officer
authorized by the company and should state the date of the deposit, the
name of the depositor, the amount in words and figures, rate of interest
payable, maturity date and amount.
In the case of brokers/agents etc collecting public deposits on behalf of

NBFCs, the depositors should satisfy themselves that the brokers/agents
are duly authorized by the NBFC.
The depositor must bear in mind that public deposits are unsecured and
Deposit Insurance facility is not available to depositors of NBFCs.
The Reserve Bank of India does not accept any responsibility or guarantee
about the present position as to the financial soundness of the company or
for the correctness of any of the statements or representations made or
opinions expressed by the company and for repayment of deposits/
discharge of the liabilities by the company.
Does RBI Guarantee the Repayment of the Deposits Collected by

NBFCs?
No. The Reserve Bank does not guarantee repayment of deposits by NBFCs
even though they may be authorized to collect deposits. As such, investors
and depositors should take informed decisions while placing deposit with
an NBFC.
In case an NBFC defaults in Repayment of Deposit what Course of

action can be Taken by Depositors?
If an NBFC defaults in repayment of deposit, the depositor can approach

Company Law Board (NCLT) or Consumer Forum or file a civil suit in a
court of law to recover the deposits. NBFCs are also advised to follow a
grievance redress procedure as indicated in reply to question 57 below.
Further, at the level of the State Government, the State Legislations on
Protection of Interest of Depositors (in Financial Establishments) empowers
the State Governments to take action even before the default takes place
! !168
or complaints are received from depositors. If there is perpetration of an

offence and if the intention is to defraud, the State Government can even
attach properties.
What is the Role of Company Law Board (NCLT) in Protecting the

Interest of Depositors? How can one Approach It?
When an NBFC fails to repay any deposit or part thereof in accordance with
the terms and conditions of such deposit, the Company Law Board (NCLT)
either on its own motion or on an application from the depositor, directs by
order the Non-Banking Financial Company to make repayment of such
deposit or part thereof forthwith or within such time and subject to such
conditions as may be specified in the order. After making the payment, the
company will need to file the compliance with the local office of the
Reserve Bank of India.
As explained above, the depositor can approach NCLT by mailing an

application in prescribed form to the appropriate bench of the Company
Law Board(NCLT) according to its territorial jurisdiction along with the
prescribed fee.
We hear that in a Number of Cases Official Liquidators have been

Appointed on the Defaulting NBFCs. What is the Procedure Adopted
by the Official Liquidator?
An Official Liquidator is appointed by the court after giving the company

reasonable opportunity of being heard in a winding up petition. The
liquidator performs the duties of winding up of the company and such
duties in reference thereto as the court may impose. Where the court has
appointed an official liquidator or provisional liquidator, he becomes
custodian of the property of the company and runs day-to-day affairs of
the company. He has to draw up a statement of affairs of the company in
prescribed form containing particulars of assets of the company, its debts
and liabilities, names/residences/occupations of its creditors, the debts due
to the company and such other information as may be prescribed. The
scheme is drawn up by the liquidator and same is put up to the court for
approval. The liquidator realizes the assets of the company and arranges to
repay the creditors according to the scheme approved by the court. The
liquidator generally inserts advertisement in the newspaper inviting claims
from depositors/investors in compliance with court orders. Therefore, the
! !169
investors/depositors should file the claims within due time as per such
notices of the liquidator. The Reserve Bank also provides assistance to the
depositors in furnishing addresses of the official liquidator.
The Consumer Court Plays useful role in Attending to Depositors

Problems. Can One Approach Consumer Forum, Civil Court, CLB
Simultaneously?
Yes, a depositor can approach any or all of the redressal authorities i.e
consumer forum, court or CLB.
Companies Registered with MCA but not Registered with RBI as

NBFCs also Sometimes Default in Repayment of Deposit/Amounts
Invested with them? What is the Recourse Available to the
Investors in such an event? Does RBI have any role to play in such
cases?
Companies registered with MCA but not required to be registered with RBI
as NBFC are not under the regulatory domain of RBI. Whenever RBI
receives any such complaints about the companies registered with MCA but
not registered with RBI as NBFCs, it forwards the complaints to the
Registrar of Companies (ROC) of the respective state for any action.
Is there an Ombudsman for hearing complaints against NBFCs or

Does RBI have any grievance redressal mechanism in place for
NBFCs?
No, there is no Ombudsman for hearing complaints against NBFCs.

However, in respect of credit card operations of an NBFC, which is a
subsidiary of a bank, if a complainant does not get satisfactory response
from the NBFC within a maximum period of thirty (30) days from the date
of lodging the complaint, the customer will have the option to approach the
Office of the concerned Banking Ombudsman for redressal of his grievance/
s.
The NBFCs have been made liable to pay interest on the overdue
matured deposits if the company has not been able to repay the
matured public deposits on receipt of a claim from the depositor.
Please elaborate the provisions.
! !170
As per Reserve Bank’s Directions, overdue interest is payable to the

depositors in case the company has delayed the repayment of matured
deposits, and such interest is payable from the date of receipt of such
claim by the company or the date of maturity of the deposit whichever is
later, till the date of actual payment. If the depositor has lodged his claim
after the date of maturity, the company would be liable to pay interest for
the period from the date of claim till the date of repayment. For the period
between the date of maturity and the date of claim it is the discretion of
the company to pay interest.
Can a company pre-pay its public deposits?
An NBFC accepts deposits under a mutual contract with its depositors. In

case a depositor requests for pre-mature payment, Reserve Bank of India
has prescribed Regulations for such an eventuality in the Non-Banking
Financial Companies Acceptance of Public Deposits (Reserve Bank)
Directions, 1998 wherein it is specified that NBFCs cannot grant any loan
against a public deposit or make premature repayment of a public deposit
within a period of three months (lock-in period) from the date of its
acceptance. However, in the event of death of a depositor, the company
may, even within the lock-in period, repay the deposit at the request of the
joint holders with survivor clause/nominee/ legal heir only against
submission of relevant proof, to the satisfaction of the company
An NBFC, (which is not a problem company) subject to above provisions,

may permit after the lock–in period, premature repayment of a public
deposit at its sole discretion, at the rate of interest prescribed by the Bank
A problem NBFC is prohibited from making premature repayment of any
deposits or granting any loan against public deposit/deposits, as the case
may be. The prohibition shall not, however, apply in the case of death of
depositor or repayment of tiny deposits i.e. up to ₹ 10000/- subject to lock
in period of 3 months in the latter case.
What is the liquid assets requirement for the deposit taking

companies?
Where are these assets kept? Do depositors have any claims on

them?
! !171
In terms of Section 45-IB of the RBI Act, 1934, the minimum level of liquid
assets to be maintained by NBFCs is 15 per cent of public deposits
outstanding as on the last working day of the second preceding quarter. Of
the 15%, NBFCs are required to invest not less than ten percent in
approved securities and the remaining 5% can be in unencumbered term
deposits with any scheduled commercial bank. Thus, the liquid assets may
consist of Government securities, Government guaranteed bonds and term
deposits with any scheduled commercial bank.
The investment in Government securities should be in dematerialised form

which can be maintained in Constituents’ Subsidiary General Ledger
(CSGL) Account with a scheduled commercial bank (SCB)/Stock Holding
Corporation of India Limited (SHICL). In case of Government guaranteed
bonds the same may be kept in dematerialised form with SCB/SHCIL or in
a dematerialised account with depositories [National Securities Depository
Ltd. (NSDL)/Central Depository Services (India) Ltd. (CDSL)] through a
depository participant registered with Securities & Exchange Board of India
(SEBI). However in case there are Government bonds which are in physical
form the same may be kept in safe custody of SCB/SHCIL.
NBFCs have been directed to maintain the mandated liquid asset securities
in a dematerialised form with the entities stated above at a place where
the registered office of the company is situated. However, if an NBFC
intends to entrust the securities at a place other than the place at which its
registered office is located, it may do so after obtaining the permission of
RBI in writing. It may be noted that liquid assets in approved securities will
have to be maintained in dematerialised form only. The liquid assets
maintained as above are to be utilised for payment of claims of depositors.
However, deposits being unsecured in nature, depositors do not have direct
claim on liquid assets.
What does RBI do to protect the interest of NBFC depositors?
RBI has issued detailed regulations on deposit acceptance, including the

quantum of deposits that can be collected, mandatory credit rating,
mandatory maintenance of liquid assets for repayment to depositors,
manner of maintenance of its deposit books, prudential regulations
including maintenance of adequate capital, limitations on exposures, and
inspection of the NBFCs, besides others, to ensure that the NBFCs function
on sound lines. If the Bank observes through its inspection or audit of any
! !172
NBFC or through complaints or through market intelligence, that a certain

NBFC is not complying with RBI directions, it may prohibit the NBFC from
accepting further deposits and prohibit it from selling its assets. In
addition, if the depositor has complained to the Company Law Board (CLB)
which has ordered repayment and the NBFC has not complied with the CLB
order, RBI can initiate prosecution of the NBFC, including criminal action
and winding up of the company.
More importantly, RBI initiates prompt action, including imposing penalties

and taking legal action against companies which are found to be violating
RBI's instructions/norms on basis of Market Intelligence reports,
complaints, exception reports from statutory auditors of the companies,
information received through SLCC meetings, etc. The Reserve Bank
immediately shares such information with all the financial sector regulators
and enforcement agencies in the State Level Coordination Committee
Meetings.
As a premier public policy institution, as part of its public policy measure,

the Reserve Bank of India has been in the forefront in taking several
initiatives to create awareness among the general public on the need to be
careful while investing their hard earned money. The initiatives include
issue of cautionary notices in print media and distribution of informative
and educative brochures/pamphlets and close interaction with the public
during awareness/outreach programs, Townhall events, participation in
State Government sponsored trade fairs and exhibitions. At times, it even
requests newspapers with large circulation (English and vernacular) to
desist from accepting advertisements from unincorporated entities seeking
deposits.
Who rates deposit taking NBFCs for acceptance of deposit?
NBFCs may get itself rated by any of the six rating agencies namely,
CRISIL, CARE, ICRA, FITCH Ratings India Pvt. Ltd, Brickwork Ratings India
Pvt. Ltd. and SMERA.
! !173
What are the symbols of minimum investment grade rating of

different companies? When a company’s rating is downgraded,
does it have to bring down its level of public deposits immediately
or over a period of time?
Name of Rating Agencies Nomenclature of Minimum

Investment 
Grade Credit Rating (MIGR)
CRISIL FA-(FA MINUS)
ICRA MA- (MA MINUS)
CARE CARE BBB (FD)
FITCH Ratings India Pvt. Ltd.  tA-(ind)(FD) 

SMERA SMERA A
Brickwork Ratings India Pvt. Ltd BWR FBBB
The symbols of minimum investment grade rating of the Credit rating

agencies are:
It may be added that A- is not equivalent to A, AA- is not equivalent to AA

and AAA- is not equivalent to AAA.
However, if rating of an NBFC is downgraded to below minimum investment

grade rating, it has to stop accepting public deposits, report the position
within fifteen working days to the RBI and bring within three years from
the date of such downgrading of credit rating, the amount of public deposit
to nil. With the introduction of revised regulatory framework in November
2014 deposit taking NBFCs have to mandatorily get investment grade
credit rating for being eligible to accept public deposits.
What is the purpose of enacting Protection of Interest of

Depositors in Financial Establishments Act by the State
Governments?
The purpose of enacting this law is to protect the interests of the

depositors. The provisions of RBI Act are directed towards enabling RBI to
issue prudential regulations that make the financial entities function on
sound lines. RBI is a civil body and the RBI act is a civil Act. Both do not
have specific provisions to effect recovery by attachment and sale of assets
! !174
of the defaulting companies, entities or their officials. It is the State

government machinery which can effectively do this. The Protection of
Interest of Depositors in Financial Establishments Acts, confers adequate
powers on the State Governments to attach and sell assets of the
defaulting companies, entities and their officials.
Still there are cases of unscrupulous financial entities cheating

public time and again. How does RBI plan to strengthen its
surveillance on unauthorized acceptance of deposits/unauthorized
conduct of NBFI business by companies?
The Reserve Bank is strengthening its market intelligence function in

various Regional Offices and is constantly examining the financials of
companies, references for which have been received through market
intelligence or complaints to the Reserve Bank. In this, context, members
of public can contribute a great deal by being vigilant and lodging a
complaint immediately if they come across any financial entity that
contravenes the RBI Act. For example, if they are accepting deposits
unauthorisedly and/conducting NBFC activities without obtaining due
permission from the RBI. More importantly, these entities will not be able
to function if members of public start investing wisely. Members of the
public must know that high returns on investments will also have high
risks. And there can be no assured return for speculative activities. Before
investing the public must ensure that the entity they are investing in is a
regulated entity with one of the financial sector regulators.
Advertisement Issued in Public Interest relating to Deposits in

NBFCs
Source: https://www.rbi.org.in/Scripts/BS_NBFCDepositors.aspx)
Non-banking financial institutions (NBFIs), engaged in varied financial

activities are part of the Indian financial system providing a range of
financial services. NBFCs are incorporated under the Companies Act, 1956.
NBFCs can be classified into two broad categories, viz., (i) NBFCs accepting
public deposit (NBFCs-D) and (ii) NBFCs not accepting/holding public
deposit (NBFCs-ND). Residuary Non-Banking Companies(RNBCs) are
another category of NBFCs whose principal business is acceptance of
deposits and investing in approved securities. In the interest of depositors,
RBI has evolved a regulatory framework the salient features of which are
! !175
outlined below for the guidance of depositors. However, the investors

must carefully evaluate their investment decisions while investing
in NBFCs, as the instructions below are illustrative and not
exhaustive,
NBFCs include a loan company, an investment company, asset finance

company (i.e. a company conducting the business of equipment leasing or
hire purchase finance) and Residuary Non-Banking Companies.
An NBFC must be registered with the Reserve Bank of India (RBI) and have
specific authorization to accept deposits from the public.
NBFC must display the Certificate of Registration or a certified copy thereof

at the Registered office and other offices/branches.
Registration of an NBFC with the RBI merely authorizes it to conduct the

business of NBFC. RBI does not guarantee the repayment of deposits
accepted by NBFCs. NBFCs cannot use the name of the RBI in any manner
while conducting their business.
The NBFC whose application for grant of Certificate of Registration (CoR)

has been rejected or cancelled by the RBI is neither authorized to accept
fresh deposits nor renew existing deposit. Such rejection or cancellation is
also published in newspapers from time to time. Besides, a list of NBFCs
permitted to accept public deposits, NBFCs whose applications for CoR has
been rejected or whose CoR has been cancelled by the RBI is available on
the RBI’s web site www.rbi.org.in (go to site map and then NBFC list)
NBFCs which accept deposits should have minimum investment grade

credit rating granted by an approved credit rating agency for deposit
collection, except certain Asset Finance (equipment leasing and hire
purchase finance) companies and Residuary Non-Banking Companies
(RNBCs),
! !176
NBFCs excluding RNBCs cannot
• Offer a rate of interest on deposits more than that approved by RBI from
time to time (at present 12.5%).
• Accept deposit for a period less than 12 months and more than 60
months
• Offer any gifts/incentives to solicit deposits from public.
RNBCs should
• offer a rate of interest of not less than 5% per annum on term deposits
and 3.5% on daily deposits, both compounded annually, under extant
directions.
• RNBCs cannot accept deposits for a period less than 12 months and more
than 84 months.
• RNBCs cannot offer any gifts/incentives to solicit deposits from public
• NBFCs including RNBCs can
• accept deposit only against issue of proper receipt.
• The receipt should bear the name of the company and should be signed
by an authorized official of the company.
• The receipt should mention the name of the depositor, the amount in
words as well as figures, the rate of interest payable on the deposit
amount and the date of repayment of matured deposit along with the
maturity amount.
In the case of brokers/agents etc collecting public deposits on behalf of

NBFCs, the depositors should satisfy themselves that the brokers/agents
are duly authorized by the NBFC.
! !177
If a deposit taking NBFC fails to repay the deposit or the interest accrued
thereon in accordance with the terms and conditions of acceptance of such
deposit, redressal of grievance can be through, -the Regional Bench of the
Company Law Board at Chennai/Delhi/Kolkata/Mumbai
Acceptance of deposits by companies engaged in activities including

plantation activities, commodities trading, multilevel marketing,
manufacturing activities, housing finance, nidhis (mutual benefit financial
companies), and potential nidhis (mutual benefit company) and companies
engaged in collective investment schemes do not come under the purview/
regulations of the RBI.
Individuals, firms and other unincorporated association of individuals or

bodies shall not accept deposits from the public–
1. if his or its business wholly or partly includes any of the financial

activities such as loans and advances, acquisition of shares or
marketable securities, leasing or hire purchase activities, or
2. if his or its principal business is that of receiving deposits or lending in

any manner.
! !178
Source: https://www.bajajcapital.com/fixed-deposits/fixed-deposit-
introduction.aspx
Bajaj Capital Limited one of India’s premier investment companies an

incredible range of financial products to choose from on its website. The
website provides specific information on Fixed Deposits as follows:
What are Company Fixed Deposits?
The deposits made by investors in companies that earn a fixed rate of

return over a period of time are called Company Fixed Deposits. Along with
manufacturing companies, financial institutions and Non-Banking Finance
Companies (NBFCs) also accept these deposits.
Benefits of Company Fixed Deposits
Higher interest rate: The rate of interest is 2-4 percent high, as

compared to the interest rate offered by banks on fixed deposits
Regular income: Depending on the scheme, investors have the option to

receive interest at monthly/quarterly/half-yearly/yearly intervals
Lock-in period: The minimum lock-in period for most of the schemes is
six months, i.e. investors can withdraw their money post six months,
anytime
TDS: TDS is not applicable if interest earned is equals to or less than 5,000
for a year in a single company.
Important things to Consider
Investors must carefully read the application form
Check the rating of the company before investing
Do a background check of the company before putting money into it
Companies may change the interest rates on the fixed deposit schemes
without any prior notice
! !179
Disclaimer
Bajaj Capital Limited (BCL) only acts as a mediator between its clients and
the company inviting/accepting fixed deposits, known as Principal
Company. Neither BCL nor its employees, directors, agents etc., endorse
and/or certify the information provided by the Principal Company and shall
not be liable (legally or otherwise) under any circumstances.
Investors can also view a list of company fixed deposits offered by

different companies and compare them from the Bajaj Capital
website as follows:
!
Source: https://www.bajajcapital.com/fixed-deposits/company-fixed-
deposits.aspx
! !180
Source : https://www.bajajfinserv.in/fixed-deposit
The Bajaj Finance Fixed Deposit provides various options for children
women and other to invest in fixed deposit.
Anyone eligible investor can choose tenor between 12 months and 60

months, as per his financial needs.
Features and Benefits of Bajaj Finance Fixed Deposits:
8.75% Return on Your Investment which can go up to 9.10%
Higher Interest Rates for Senior Citizens: 0.35% over and above the
regular interest rate
Minimum deposit of Rs. 25,000
High Stability and Credibility: ICRA’s MAAA (stable) rating and CRISIL’s
FAAA/Stable rating,
! !181
Assured Returns
Flexible Tenors: 15 month special tenure FD which offers 0.25% more

than the ROI of a 12 month FD.
Fixed Deposit Calculator: to evaluate your returns in advance, before

making an investment.
Online Application Process which saves you time and trouble
Online Account Management
200+ Branches Across India
Source: https://www.mahindrafinance.com/fixed-deposit.aspx
Mahindra Finance is one of the leading non-banking finance companies,

having touched over 4 million lives. Mahindra Finance's Fixed Deposit
scheme provides fixed guaranteed returns at highly competitive FD interest
! !182
rates with this low-risk investment. Investors also have an option to book
online FD.
The MMFSL Fixed Deposit has a Crisil rating of 'FAAA', which indicates a
high level of safety. 0.25% additional interest rate is offered for senior
citizens for Samruddhi Fixed Deposits. 0.35% additional interest rate is
offered for all Mahindra group company employees & employees’ relatives
for Samruddhi Fixed Deposits. 0.10% additional interest rate is offered for
Senior Citizens for Dhanvruddhi Deposits(Mode of investment-Only Online
transaction through MMFSL website)
5.4 Acceptance of deposits by Housing Finance Companies
The deposit acceptance activities of housing finance companies are

regulated by National Housing Bank.
Master Circular - The Housing Finance Companies (NHB) Directions,

2010 NHB(ND)/DRS/REG/MC-01/2016 dated July 1, 2016 of National
Housing Bank gives the following directions on acceptance of public
deposits.
“deposit” shall have the same meaning as assigned to it in Section 45 I

(bb) of the Reserve Bank of India Act, 1934
“depositor” means any person who has made a deposit with the housing
finance company or a heir, legal representative, administrator or assignee
of the depositor.
! !183
Restriction on Acceptance of Deposits
1. No housing finance company shall accept or renew public deposits

unless the housing finance company has obtained minimum investment
grade rating for its fixed deposits from any one of the approved rating
agencies, at least once a year and a copy of the rating is sent to the
National Housing Bank and it is complying with all the prudential norms,
provided that:
a. a housing finance company having obtained credit rating for its fixed
deposits not below the minimum investment grade rating as above
and complying with all the prudential norms, may accept public
deposits not exceeding five times of its NOF.
b. a housing finance company which does not have the requisite rating
for its fixed deposits shall obtain the same within a period of six
months’ time from the date of notification or such extended period as
may be permitted by the National Housing Bank, to obtain the
prescribed rating for its fixed deposits.
Approved Credit Rating Agencies and the Minimum Investment

Grade Credit Rating
The names of approved credit rating agencies and the minimum credit
rating shall be as follows:-
Minimum Investment
Name of the Agency
Grade Rating
(a) The Credit Rating Information Services FA- (FA Minus)
of India Ltd. (CRISIL)
(b) ICRA Ltd. MA- (MA Minus)
(c) Credit Analysis & Research Ltd. (CARE) CARE BBB(FD)
(d) FITCH Ratings India Private Ltd. tA-(ind)(FD)

(e) Brickwork Ratings India Pvt. Ltd. BWR FA]
2. No housing finance company shall have deposits inclusive of public

deposits, the aggregate amount of which together with the amounts, if
any, held by it which are referred in clauses (iii) to (vii) of sub-section
! !184
(bb) of Section 45 I of the Reserve Bank of India Act, 1934 (2 of 1934)

as also loans or other assistance from the National Housing Bank, is in
excess of sixteen times of its NOF.
3. Where a housing finance company holds as on the date of

commencement of these directions public deposits in excess of the
limits specified in (1) above and as applicable to it or deposits inclusive
of the items mentioned in (2) above in excess of the limits specified in
(2) above, it shall- (i) not accept fresh deposit or open new deposit
account; or (ii) not renew the existing deposit or where the deposits are
received under any recurring scheme, receive installments under such
scheme after the expiry of the scheme period; (iii) reduce such excess
deposit by repayment on maturity.
4. In the event of down gradation of the credit rating to any level below
investment grade, the housing finance company shall (i) report the
position within fifteen working days to the National Housing Bank; (ii)
with immediate effect stop accepting fresh public deposit and (iii)
reduce such excess deposit by repayment on maturity.
Period of Deposits
No housing finance company shall accept or renew any public deposit:
a. which is repayable on demand or on notice; or
b. unless such deposit is repayable after a period of twelve months or

more but not later than one hundred and twenty months from the date
of acceptance or renewal of such deposits.
Explanation
Where a public deposit is in Instalments, the period of such deposit shall

be computed from the date of receipt of first Installment.
Joint deposit
Where so desired, deposits may be accepted in joint names with or without

any of the clauses, namely, “Either or Survivor”, “Number One or Survivor/
s”, “Anyone or Survivor/s”.
! !185
Particulars to be Specified in Application form Soliciting Public

Deposits
1. No housing finance company shall accept or renew any public deposit

except on a written application from the depositors in the form to be
supplied by the housing finance company, which form shall contain all
the particulars specified in the Non-Banking Financial Companies and
Miscellaneous Non-Banking Companies (Advertisement) Rules, 1977,
made under the Companies Act and also contain the particulars of the
specific category of the depositors, i.e. whether the depositor is a
shareholder or a director or a promoter of the housing finance company
or a member of public or a relative of a director of the company.
2. The application form shall also contain the following:-
a. the credit rating assigned for its deposits and the name of the credit
rating agency which rated the housing finance company;
b. a statement to the effect that in case of any deficiency of the housing

finance company in servicing its deposits, the depositor may approach
the National Consumers Disputes Redressal Forum, the State Level
Consumers Disputes Redressal Forum or the District Level Consumers
Dispute Redressal Forum for relief;
c. a statement to the effect that in case of non-repayment of the deposit

or part thereof in accordance with the terms and conditions of the
deposit, the depositor may make an application to authorised officer of
the National Housing Bank;
d. a statement to the effect that the financial position of the housing

finance company as disclosed and the representations made in the
application form are true and correct and that the housing finance
company and its Board of Directors are responsible for the correctness
and veracity thereof;
e. a statement to the effect that the housing finance company is within the
regulatory framework of the National Housing Bank. It must, however,
be distinctly understood that the National Housing Bank does not
undertake any responsibility for the financial soundness of the housing
finance company or for the correctness of any of the statements or the
! !186
representations made or opinions expressed by the housing finance

company; and for repayment of deposit/discharge of liabilities by the
housing finance company;
f. the information relating to and the aggregate dues from the facilities,
both fund and non-fund based, extended to, and the aggregate dues
from companies in the same group or other entities or business
ventures in which the directors and/or the housing finance company
are/is holding substantial interest and the total amount of exposure to
such entities;
g. at the end of application form but before signature of the depositor, the
following verification clause by the depositor shall be appended. “I have
gone through the financial and other statements/particulars/
representations furnished/made by the housing finance company and
after careful consideration I am making the deposit with the housing
finance company at my own risk and volition.
Introduction of Depositors
Every housing finance company shall obtain proper introduction of new

depositors before opening their accounts and accepting the deposits, and
shall keep on its record the evidence on which it has relied for the purpose
of such introduction.
Explanation
For the purpose of this paragraph, introduction shall mean identification of

the prospective depositor and may be done either by one of the existing
depositors or on the basis of any one of Income Tax Permanent Account
Number (PAN), ElectionIdentity Card, Passport, or Ration Card.
! !187
Furnishing of Receipts to Depositors
1. Every housing finance company shall furnish to every depositor or his

agent, unless, it has done so already, a receipt for every amount which
has been or which may be received by the housing finance company by
way of deposit before or after the date of commencement of these
Directions.
2. The said receipt should be duly signed by an officer entitled to act for
the housing finance company in this behalf and shall state the date of
deposit, the name of depositor, the amount in words and figures
received by the housing finance company by way of deposit, rate of
interest payable thereon and the date on which the deposit is repayable.
Provided that, if such receipts pertain to Installments subsequent to the

first installment of a recurring deposit it may contain only name of the
depositor/s, date and amount of deposit.
Register of Deposits
1. Every housing finance company shall keep one or more registers in

which shall be entered separately in the case of each depositor or group
of joint depositors the following particulars, namely,
a. name and address of the depositor or group of joint depositors, their

nominees,
b. date and amount of each deposit,
c. duration and due date of each deposit,
d. date and amount of accrued interest or premium on each deposit,
e. date and amount of each repayment, whether of principal, interest or

premium,
f. date of claim made by the depositor,
g. the reasons for delay in repayment beyond five working days, and
! !188
h. any other particulars relating to the deposits.
2. The register or registers aforesaid shall be kept at each branch in

respect of the deposit accounts opened by that branch of the housing
finance company and a consolidated register for all the branches taken
together at the registered office of the housing finance company and
shall be preserved in good order for a period of not less than eight years
following the financial year in which the latest entry is made of the
repayment or renewal of any deposit of which particulars are contained
in the register:
Provided that, if the housing finance company keeps the books of account
referred to the Companies Act, at anyplace other than its Registered Office
in accordance with the provisions it shall be sufficient compliance with this
sub-paragraph if the register aforesaid is kept at such other place, subject
to the condition that the housing finance company delivers to the National
Housing Bank a copy of the notice filed with the Registrar under the
proviso to the said sub-section within seven days of such filing.
General Provisions Regarding Repayment of Deposits
1. No housing finance company shall repay any public deposit within a

period of three months from the date of its acceptance.
2. Where a housing finance company at the request of depositor/s repays

a public deposit after the period indicated in clause (i) above but before
its maturity, it shall pay interest at the following rate: 
! !189
(a) minimum lock in period Three months
(b) after three months but The maximum interest payable shall
before six months be four percent per annum for
individual depositor, and no interest
in case of other depositors
(c) after six months but before the The interest payable shall be one
date of maturity percent lower than the interest rate
applicable to a public deposit for the
period for which the deposit has run
or if no rate has been specified for
that period, then 15[two percent]
lower than the minimum rate at
which the public deposits are
accepted by that Housing Finance
Company.
3. A housing finance company may grant a loan up to seventy-five percent

of the amount of public deposit to a depositor after the expiry of three
months from the date of public deposit at a rate of interest two
percentage points above the interest rate payable on the public deposit.
4. It is obligatory on the part of a housing finance company to intimate the

details of maturity of the deposit to the depositor at least fourteen days
before the date of maturity of the deposit.
5. all deposit accounts standing to the credit of sole/first named depositor

in the same capacity shall be clubbed and treated as one deposit
account for the purpose of premature repayment or grant of loan by a
problem housing finance company
6. Provided that in the event of death of a depositor, the public deposit

may be paid prematurely to the surviving depositor/s in the case of joint
holding with the survivor clause, or to the nominee or legal heir/s with
interest at the contracted rate up to the date of repayment.
7. For the purpose, housing finance companies are classified into two
categories viz. a problem housing finance company and a normally run
housing finance company. A housing finance company, which is normally
run housing finance company, with effect from the date of this
! !190
notification,can permit premature repayment of a public deposit after

the lock-in periodat its sole discretion only and premature closure
cannot be claimed as a matter of right by the depositors. The problem
housing finance companies have been prohibited from making
premature repayment of any public deposits or granting any loan
against public deposits except in the case of death of the depositor or in
the case of tiny deposit up to 10,000 in entirety or to enable the
depositor to meet expenses of an emergent nature up to an amount not
exceeding 10,000
Renewal of Public Deposit before Maturity
Where any housing finance company permits an existing depositor to

renew his public deposit before maturity for availing the benefit of higher
rate of interest, such company shall pay the depositor the increase in the
rate of interest provided, (i) the public deposit is renewed in accordance
with the other provisions of these directions and for a period longer than
the remaining period of the original contract; and (ii) the interest on the
expired period of the public deposit is reduced by one percentage point
from the rate at which the housing finance company would have ordinarily
paid, had the deposit been accepted for the period for which such public
deposit had run; any interest paid earlier in excess of such reduced rate is
recovered/adjusted.
Creation of Floating Charge in Favour of the Depositors
All Housing Finance Companies accepting/holding public deposits shall

create floating charge on the assets invested by them in terms of sub-
sections (1) and (2) of Section 29B of the National Housing Bank Act, 1987
in favour of their depositors in a manner as may be prescribed by National
Housing Bank from time to time, in this behalf.
! !191
Advertisements and Statement in Lieu of Advertisement
1. Every housing finance company soliciting public deposits shall comply

with the provisions of the Non-Banking Financial Companies and
Miscellaneous Non- Banking Companies (Advertisement) Rules, 1977
and shall also specify in every advertisement to be issued there under,
the following:
a. the actual rate of return by way of interest, premium, bonus or other

advantage to the depositors;
b. the mode of payment to the depositors;
c. maturity period of deposits;
d. the interest payable on a specified deposit;
e. the rate of interest which will be payable to the depositors in case the
depositor withdraws the deposit prematurely;
f. the terms and conditions subject to which a deposit will be renewed;
g. any other special features relating to the terms and conditions
subject to which the deposits are accepted/ renewed;
h. the information, relating to the aggregate dues (including the non-
fund based facilities) provided to/from companies in the same group
or other entities or business ventures in which the directors and/or
the housing finance company are holding substantial interest and the
total amount of exposure to such entities; and
i. the deposits solicited by it are not insured.
1a. Where a housing finance company displays any advertisement

in electronic media such as TV, even without soliciting deposits, it should
incorporate a caption/band in such advertisements indicating the following:
As regards deposit taking activity of the company, the viewers may refer to
the advertisement in the newspaper/information furnished in the
application form for soliciting public deposits;
The company is having a valid Certificate of Registration dated xx-xx-xxxx

issued by the National Housing Bank under Section 29A of the National
Housing Bank Act, 1987. However, the National Housing Bank does not
accept any responsibility or guarantee about the present position as to the
financial soundness of the company or for the correctness of any of the
statements or representations made or opinions expressed by the company
and for repayment of deposits/discharge of the liabilities by the company.]
! !192
2. Where a housing finance company intends to accept public deposits

without inviting or allowing or causing any other person to invite such
deposits, it shall, before accepting deposits, deliver to the office of the
National Housing Bank at New Delhi for registration, a statement in lieu
of advertisement containing all the particulars required to be included in
the advertisement pursuant to the Non-Banking Financial Companies
and Miscellaneous Non-Banking Companies (Advertisement) Rules, 1977
as also the particulars stated in sub-paragraph (1) herein above, duly
signed in the manner provided in the aforesaid Rules.
3. A statement, delivered under sub-paragraph (2) shall be valid till the

expiry of six months from the date of closure of the financial year in
which it is so delivered, or until the date on which the balance sheet is
laid before the annual general meeting, or where the annual general
meeting for any year has not been held, the latest day on which that
meeting should have been held in accordance with the provisions of the
Companies Act, whichever is earlier and a fresh statement shall be
delivered in each succeeding financial year before accepting deposits in
that financial year.
As per Section 29 A of National Housing Bank Act,1987,

Requirement of Registration and Net Owned Fund
1. Notwithstanding anything contained in this Chapter or in any other law

for the time being in force, no housing finance institution which is a
company shall commence or carry on the business of a housing finance
institution without -
a. obtaining a certificate of registration issued under this Chapter; and
b. having the net owned fund of two crores rupees or such other higher
amount, as the National Housing Bank may, by notification, specify.
2. Every such housing finance institution shall make an application for

registration to the National Housing Bank in such form as may be
specified by the National Housing Bank
! !193
NHB issues Certificate of Registration
NHB regulations demands that all the housing finance institutions, set up
as a company must obtain a certificate of registration from the National
Housing Bank.
Interest rate and brokerage shall be as decided by NHB from time to time.
For latest information on acceptance of deposits NHB website may be
referred.
List of Housing Finance Companies granted Certificate of

Registration (COR)
under Section 29A of the National Housing Bank Act, 1987 https://
test.nhb.org.in/Regulation/RegisteredCompanies.php
The updated rules and regulations of NHB could be found in this link NHB
Regulations – Circular
Sl.
Name of the HFC Registered Office Address
No
1 Can Fin Homes Limited No. 29/1, 1st Floor, Sir M.N. Krishna Rao
Road, Basavangudi, Bangalore-560 004.
KARNATAKA.
2 Cent Bank Home Finance 9-Arera Hills,Mother Teresa Road,

Limited Bhopal-462011. MADHYA PRADESH
3 Dewan Housing Finance Warden House (2nd Floor), Sir P.M. Road,
Corporation Ltd. Fort, Mumbai - 400023. MAHARASHTRA
4 DHFL Vysya Housing Finance S-401, 4th Floor, Brigade Plaza, Anand
Ltd. Circle, Banglore - 560 011, KARNATAKA
5 GIC Housing Finance Ltd Universal Insurance Building (3rd Floor),
Sir PM Road, Fort, Mumbai-400 001.
MAHARASHTRA. GUJRAT.
6 GRUH Finance Ltd "GRUH", Netaji Marg, Nr. Mithakhali Six

Road, Ellisbridge, Ahmedabad-380 006.
GUJARAT.
! !194
7 Housing and Urban HUDCO Bhawan, India Habitat Centre,

Development Corporation Ltd. Lodhi Road, New Delhi-110003.DELHI.
8 Housing Development Finance Ramon House, H.T. Parekh Marg, 169-
Corporation Ltd. Backbay Reclamation, Church Gate,
Mumbai-400 020. MAHARASHTRA
9 ICICI Home Finance Company ICICI Bank Towers, Bandra Kurla

Ltd. Complex, Mumbai-400 051.
MAHARASHTRA
10 Ind Bank Housing Ltd 66-RajajiSalai,Chennai-600
001.TAMILNADU
11 LIC Housing Finance Ltd Bombay Life Building, 45/47-Veer

Nariman Road, Mumbai-400 001.
MAHARASHTRA
12 Manipal Housing Finance "Manipal House", Manipal-576 119. Udupi
Syndicate Ltd District. KARNATAKA
13 National Trust Housing Finance MOH Building-1st Floor, 576 Anna Salai,
Ltd. Teynampet, Chennai-600 006.
TAMILNADU.
14 PNB Housing Finance Ltd Antriksh Bhawan-9th Floor, 22-Kasturba
Gandhi Marg, New Delhi-110001.DELHI.
15 REPCO Home Finance Ltd "Repco Tower", 33-North Usman Road, T.

Nagar, Chennai-600 017.  
TAMILNADU.
16 Sundaram BNP Paribas Home 21-Patullos Road, Chennai-600
Finance Ltd. 002.TAMILNADU
17 Vishwakriya Housing Finance Office No.117, 209, Masjid Moth, South

Ltd. Ex Plaza II, South Extn Part II, 
New Delhi - 49
18 L&T Housing Finance Limited Unit No.505 & 506, DLF Tower ‘B', District
(Formerly Indo Pacific Centre, Jasola, New Delhi – 110 025
Housing Finance Limited,
AIG Home Finance India
Limited and originally
incorporated as Weizmann
Homes Limited)
! !195
The updated rules and regulations of NHB could be found in this link NHB
Regulations – Circular
!
Source: https://www.hdfc.com/Deposits/
HDFC is one of leading provider of Housing Finance in India. HDFC has

delivered consistent performance with its Fixed Deposits and have earned
the trust of more than 6 lac depositors.
HDFC has received AAA ratings for its deposits programme from two
leading credit rating agencies (CRISIL and ICRA) for 24 consecutive years,
thus building utmost trust and confidence amongst investors and key
partners.
HDFC Depositors are serviced through its 420 inter-connected offices

spread across India with instant services provided at 77 deposit centers.
HDFC has set high benchmarks of service delivery on a continuous basis by
providing electronic payment facility for interest payment, instant loan
against deposit and many more.
! !196
A resident of India, you can choose from a wide range of deposit products
with maturities ranging from 12 to 84 months at competitive rates of
interest and with different features to suit the investment needs of
individuals. Senior citizens who are 60 years of age or older are offered an
additional 0.25% p.a. on all deposit products.
The Monthly Income Scheme of HDFC Provides the Following
• Regular monthly income.
• Monthly interest is directly credited to your bank account through

Electronic Clearing Service
• Available in Fixed and Variable Interest Rates.
• take a Loan Against Deposit after three months from the date of deposit
and up to 75% of the deposit amount, subject to the other terms and
conditions framed by HDFC. Interest on such loans will be 2% above the
deposit rate.
• request for premature withdrawal may be granted at the sole discretion

of HDFC and cannot be claimed as a matter of right, subject to the
Housing Finance Companies (NHB) Directions, 2010. Premature
withdrawal will not be allowed before completion of three months from
the date of deposit
• Nomination facility
• Renewal and repayment of deposit
• No tax deduction at source on interest paid/credited upto Rs. 5000/- in a

financial year. Income tax will be deducted at source under Section 194A
of the Income Tax Act, 1961, at the rates in force. If the depositor is not
liable to pay income tax and the interest to be paid/credited in a financial
year does not exceed the maximum amount which is not chargeable to
income tax, the depositor may submit a declaration in Form No. 15G so
that income tax is not deducted at source. In such cases, PAN
(Permanent Account Number) must be quoted in Form 15G, else the
form is invalid. Senior Citizens (60 years and above) may submit a
declaration in Form No. 15H. Section 139A(5A) of the Income-tax Act,
! !197
1961 requires every person receiving any sum or income from which tax
has been deducted to intimate his PAN to the person esponsible for
deducting such tax. Further, 139A(5B) requires the person deducting
such tax to indicate the PAN on the TDS certificate. In case PAN is not
mentioned, the rate of TDS would be 20% as per section 206AA(1) of the
Income-Tax Act, 1961. In case of deposits of Rs. 50,000 and above, it is
mandatory to furnish PAN.
Know Your Customer (KYC) Compliance
In terms of the Prevention of Money Laundering Act, 2002, the rules

notified thereunder and KYC Guidelines issued by the National Housing
Bank (NHB), you are required to comply with the KYC requirements by
submitting the following documents:
The latest photograph
A certified copy of the proof of identity
A certified copy of the proof of address
In case you have already submitted the above documents in an earlier

deposit, then you need not submit the above documents again, but must
provide the reference of your customer number or deposit number.
! !198
5.5 Nidhi companies
Nidhi means a company which has been incorporated with the object of
developing the habit of thrift and reserve funds amongst its members and
also receiving deposits and lending to its members only for their mutual
benefit. They are also known as Permanent Fund, Benefit Funds, Mutual
Benefit Funds and Mutual Benefit Company
The primary object of Nidhis is to carry on the business of accepting

deposits and lending money to members. Only individuals can be Members.
Bodies Corporate or Trusts are not admitted as Members.
The area of operation of Nidhi company was initially within the

municipalities and panchayats. However some Nidhis could open branches
within the respective revenue district and even outside on account of their
financial and administrative strength.
A Nidhi company, is one that belongs to the non-banking Indian finance

sector and is recognized under section 406 of the Companies Act, 2013.
Their core business is borrowing and lending money between their
members. They are regulated by Ministry of Corporate Affairs. Reserve
Bank of India is empowered to issue directions to them in matters relating
to their deposit acceptance activities.
Nidhi companies is governed by Nidhi Rules, 2014. They are incorporated

in the nature of Public Limited company and hence, they have to comply
with two set of norms, one of Public limited company as per Companies
Act, 2013 and another is for Nidhi rules, 2014. No RBI approval is
necessary to register the company, as RBI has specifically exempted this
category of NBFC in India to comply its core provisions such as registration
with RBI etc.
! !199
Incorporation of a Nidhi Company
A Nidhi Company, is a Non-banking Finance Company and is

Recognized under Section 406 of the Companies Act, 2013.
Nidhi Company registration is simple and less complex as compared to

other types of finance companies like NBFC which require RBI license to
start. A Nidhi Company can be started with an initial capital of Rs. 5 lakh
and require at least seven people to start with. Nidhi Company registration
also require three directors initially. It takes around 15 to 20 days to get
Nidhi Company registered in India
1. A Nidhi to be incorporated under the Companies Act, 2013 shall be a

public company and shall have a minimum paid up equity share capital
of five lakh rupees.
2. Nidhi company shall not issue preference shares.
3. If preference shares had been issued by a Nidhi before the

commencement of the Companies Act, 2013, such preference shares
shall be redeemed in accordance with the terms of issue of such shares.
4. No Nidhi shall have any object in its Memorandum of Association other
than the object of cultivating the habit of thrift and savings amongst its
members, receiving deposits from, and lending to, its members only, for
their mutual benefit.
5. Every Company incorporated as a “Nidhi” shall have the last words

‘Nidhi Limited’ as part of its name.
Every Nidhi shall, within a Period of One Year from the

commencement of Nidhi rules, 2014, ensure that it has—
a. not less than two hundred members;
b. Net Owned Funds of ten lakh rupees or more;
c. unencumbered term deposits of not less than ten per cent of the
outstanding deposits as specified in rule 14; and
d. ratio of Net Owned Funds to deposits of not more than 1:20.
! !200
Within ninety days from the close of the first financial year after its
incorporation and where applicable, the second financial year, Nidhi shall
file a return of statutory compliances in Form NDH-1 along with such
fee as provided in Companies (Registration Offices and Fees) Rules, 2014
with the Registrar duly certified by a company secretary in practice or a
chartered accountant in practice or a cost accountant in practice.
General Restrictions or Prohibitions
In terms of Rule 6, Nidhi shall not —
a. carry on the business of chit fund, hire purchase finance, leasing

finance, insurance or acquisition of securities issued by any body
corporate;
b. issue preference shares, debentures or any other debt instrument by

any name or in any form whatsoever;
c. open any current account with its members;
d. acquire another company by purchase of securities or control the

composition of the Board of Directors of any other company in any
manner whatsoever or enter into any arrangement for the change of its
management, unless it has passed a special resolution in its general
meeting and also obtained the previous approval of the Regional
Director having jurisdiction over such Nidhi;
e. carry on any business other than the business of borrowing or lending in

its own name. Nidhis which have adhered to all the provisions of these
rules may provide locker facilities on rent to its members subject to the
rental income from such facilities not exceeding twenty per cent of the
gross income of the Nidhi at any point of time during a financial year.
f. accept deposits from or lend to any person, other than its members;
g. pledge any of the assets lodged by its members as security;
h. take deposits from or lend money to any body corporate;
! !201
i. enter into any partnership arrangement in its borrowing or lending

activities;
j. issue or cause to be issued any advertisement in any form for soliciting

deposit. It may be noted that private circulation of the details of fixed
deposit Schemes among the members of the Nidhi carrying the words
“for private circulation to members only” shall not be considered to be
an advertisement for soliciting deposits.
k. pay any brokerage or incentive for mobilising deposits from members or

for deployment of funds or for granting loans.
Branches of Nidhis
1. A Nidhi may open branches, only if it has earned net profits after tax
continuously during the preceding three financial years. A Nidhi may
open up to three branches within the district.
2. If a Nidhi proposes to open more than three branches within the district
or any branch outside the district, it shall obtain the prior permission of
the Regional Director and an intimation is to be given to the Registrar
about opening of every branch within thirty days of such opening.
Acceptance of Deposits
Rule 13 of the Nidhi Rules, 2014 provides that any of the fixed deposits
accepted by a Nidhi company shall be for a minimum period of six months
and a maximum period of sixty months.
Recurring deposits shall be accepted for a minimum period of twelve

months and a maximum period of sixty months. In case of recurring
deposits relating to mortgage loans, the maximum period of recurring
deposits shall correspond to the repayment period of such loans granted by
Nidhi.
The maximum balance in a savings deposit account at any given time

qualifying for interest shall not exceed one lakh rupees at any point of time
and the rate of interest shall not exceed two per cent above the rate of
interest payable on savings bank account by nationalised banks.
! !202
A Nidhi may offer interest on fixed and recurring deposits at a rate not
exceeding the maximum rate of interest prescribed by the Reserve Bank of
India which the Non-Banking Financial Companies can pay on their public
deposits.
Following conditions should be complied by the depositor in case of a

foreclosure of a fixed deposit account or a recurring deposit account:
a. Repayment not allowed of any deposit within a period of three months

from the date of its acceptance;
b. If the deposit continues for more than a period of three months, the
depositor shall not be entitled to any interest up to six months from the
date of deposit;
c. If the repayment of a deposit is sought before the expiry of the period

for which such deposit was accepted by Nidhi, the rate of interest
payable by Nidhi on such deposit shall be reduced by two per cent from
the rate which Nidhi would have ordinarily paid, had the deposit been
accepted for the period for which such deposit had run.
In the event of death of a depositor, the deposit may be repaid

prematurely to the surviving depositor or depositors in the case of joint
holding with survivor clause, or to the nominee or to legal heir with interest
up to the date of repayment at the rate which the company would have
ordinarily paid, had such deposit been accepted for the period for which
such deposit had run.
Lending of Money (Loans) by Nidhi
According to Rule 15 A Nidhi shall provide loans only to its members

subject to the following limits, namely:—
a. two lakh rupees, where the total amount of deposits of such Nidhi from
its members is less than two crore rupees;
b. seven lakh fifty thousand rupees, where the total amount of deposits of
such Nidhi from its members is more than two crore rupees but less
than twenty crore rupees;
! !203
c. twelve lakh rupees, where the total amount of deposits of such Nidhi
from its members is more than twenty crore rupees but less than fifty
crore rupees; and
d. fifteen lakh rupees, where the total amount of deposits of such Nidhi
from its members is more than fifty crore rupees:
Where a Nidhi has not made profits continuously in the three preceding
financial years, it shall not make any fresh loans exceeding fifty per cent of
the maximum amounts of loans specified in clauses (a), (b), (c) or (d). A
member shall not be eligible for any further loan if he has borrowed any
earlier loan from the Nidhi and has defaulted in repayment of such loan.
The amount of deposits shall be calculated on the basis of the last audited
annual financial statements.
Security for Loans
A Nidhi shall give loans to its members only against the following
securities, namely:
a. gold, silver and jewellery, and the re-payment period of such loan shall
not exceed one year.
b. immovable property and, the total loans against immovable property

[excluding mortgage loans granted on the security of property by
registered mortgage, being a registered mortgage under section 69 of
the Transfer of Property Act, 1882 (IV of 1882)] shall not exceed fifty
per cent of the overall loan outstanding on the date of approval by the
board, the individual loan shall not exceed fifty per cent of the value of
property offered as security and the period of repayment of such loan
shall not exceed seven years.
c. fixed deposit receipts, National Savings Certificates, other Government

Securities and insurance policies. It may be noted that such securities
duly discharged shall be pledged with Nidhi and the maturity date of
such securities shall not fall beyond the loan period or one year
whichever is earlier and in the case of loan against fixed deposits, the
period of loan shall not exceed the unexpired period of the fixed
deposits.
! !204
Rate of Interest
The rate of interest to be charged on any loan given by a Nidhi shall not
exceed seven and half per cent above the highest rate of interest offered
on deposits by Nidhi and shall be calculated on reducing balance method.
Nidhi shall charge the same rate of interest on the borrowers in respect of
the same class of loans and the rates of interest of all classes of loans shall
be prominently displayed on the notice board at the registered office and
each branch office of Nidhi.
Returns
As per Rule 21 of the Nidhi Rules, 2014, every Nidhi company required file
half yearly return with the Registrar in Form NDH-3 along with such fee as
provided in Companies (Registration Offices and Fees)Rules, 2014 within
thirty days from the conclusion of each half year duly certified by a
company secretary in practice or chartered accountant in practice or cost
accountant in practice.
Certain Provisions of RBI Act not Applied to Notified NBFCs
Reserve Bank of India issued Master Circular dated 1st July, 2014,
pertaining to exemptions from the provisions of RBI Act, 1934 provides
that the provisions of Sections 45-IA, 45-IB and 45-IC of the Reserve Bank
of India Act, 1934 shall not apply to any non-banking financial company
Notified under the Companies Act, known as Nidhi Companies; and the
provisions contained in Non-Banking Financial Companies Acceptance of
Company; Public Deposits (Reserve Bank) Directions, 1998 shall not apply
to a Mutual Benefit Financial Company or a Mutual Benefit company
provided that the application of Mutual Benefit Company is not rejected by
Government of India under the provisions of the Companies Act.
The Central Government has been empowered under section 462 (1), to
issue in public interest, by notification, directing that any of the provisions
of Companies Act, 2013 shall not apply to such class or classes of
companies or shall apply to the class or classes of companies with such
exceptions, modifications and adaptations as may be specified in the
notification. In this context the Central Government vide notification no.
463(E) dated 5th June, 2015 directed that respective sections of the
! !205
Companies Act, 2013 shall not apply or shall apply with certain exceptions,
modification and adaptations to Government companies.
KAMLA NIDHI INDIA LTD is a company registered under the Companies

Act 2013 comes under the supervision of the MCA. A company declared as
a Nidhi or Mutual Benefit Society registered under the section 406 of the
Companies Act, 2013. Nidhis have many features which make them stand
distinctly apart from many other Non-Banking financial company who are
working under the guide line of R.B.I
Its main objective is to encourage and afford all facilities for cultivating
thrift, saving habits and to render all financial assistance to its member
only by receiving long and short term deposits and in particular recurring,
fixed and other deposits, not being current accounts from the members as
are allowed by law for Nidhi 01 Mutual Benefits Companies, and to grant
loans to the members only as against securities of immovable properties
(within City) and or on the security of deposits, movable such as gold,
silver, jewellery, Kisan Vikas Patra, National Saving Certificates Scheme,
insurance policies and other Government securities up on such terms and
condition as may from time to time prescribed in law for Nidhi or Mutual
Benefits Companies.
The savings account can be opened with a minimum balance of Rs. 1000
with nomination facility and attractive interest rate. It is mandatory to be a
member in the company and complete the KYC Norms. Company will issue
1 shares (Rs. 10) for Saving A/c.
The Recurring Deposit Plan can be opened for a tenure of 12 months

and above. Recurring Deposit minimum amount Rs. 500, thereafter in
multiples of Rs.100 Interest will be calculated on yearly basis. Loan on
deposits will be charged at 18% yearly compound interest basis. 1 month
after paying last instalment or maturity amount due date whichever is
more will be applicable for payment of maturity amount. No premature
payment within 3 months of opening.
The Fixed Deposit Plan can be opened for 12 months and above.
Minimum FD would be of Rs. 10000 and further in multiple of Rs. 1000.
TDS Deducted to be Deducted on interest. Paid by Kamla Nidhi on Deposit
as per provisions and Income tax Act. Loan available against deposits up to
! !206
70% of deposited amount after one month from the date of deposit.
Interest calculation is yearly compounding.
The Monthly Income Scheme can be opened for a tenure of 12 months

and above. Minimum deposit amount would be of Rs. 10000 and further in
multiple of Rs. 10000 Special MIS is applicable only for Senior citizens,
women, and Govt. employ and for pensioners. Rate of interest on loan
against Deposit would be 5% higher than applicable rate of interest to your
Deposit. Calculation of interest on pre-mature payment will be applicable
as per savings a/c’s rate of interest and already paid interest amount will
be deducted from the principal amount. Payment before maturity not
allowed for 90 days deposit scheme.
The Daily Deposit Scheme can be opened for a tenure of 12 months and
above. The minimum denomination of the scheme is Rs. 10 per day and in
multiples of 10. Defaulters will be charged at the rate of Rs. 2 per Rs. 100
per 15 days. All payments to the company shall be made either in cash or
by cheque/draft against the receipt countersigned by its authorized
signatory. A passbook will be issued to every Member Account Holder
which should be updated at regular intervals. Pre-Maturity is not allowed at
any point of time but member can avail loan facility. On deposit of Rs.10
per day Maturity Amount shall be paid to the Member Account Holder
within 7 days from the demand made with the company
! !207
!
Source: http://kamlanidhiindia.com
5.6 Chit Funds

by providing easier access to credit to the needy. it is one of the main parts
of the unorganized money market industry. Chit fund companies are a
category of Non-Banking Financial Companies (NBFC). The Chit funds are
exempt from being registered with the Reserve Bank of India. The
regulator of chit funds is the Registrar of Chits who is appointed by the
respective state governments under Section 61 of Chit Funds Act, 1982.
The Reserve Bank of India has allowed nonresident Indians to subscribe to
chit funds without limit on condition that they cannot take the money out
of the country, opening a new avenue to boost foreign currency inflows.
NRI subscription to chit funds should be brought in through normal banking
channel, including through an account maintained with a bank in India,
The Chit Funds business is regulated by Chit Fund Act, 1982. Chit funds are
legal under the Chit Funds Act, 1982, which is a central act but
administered by state governments
! !208
Chits are defined in Section 2 of the Chit Funds Act, 1982 as "Chit means a
transaction whether called chit, chit fund, chitty, committee, kuri or by any
other name by or under which a person enters into an agreement with a
specified of persons that every one of them shall subscribe a certain sum of
money (or a certain quantity of grain instead) by way of periodical
installments over a definite period and that each such subscriber shall, in
his turn, as determined by lot or by auction or by tender or in such other
manner as may be specified in the chit agreement, be entitled to the prize
amount”
A chit fund company is first started as a Private Limited Company with the
aim of operating a chit fund business. Once the private limited company is
formed, the company can then apply with the appropriate Chit Fund
Registrar of the State to obtain the registration. A chit fund business can
only be started after obtaining the chit fund business registration from the
relevant State Registrar. The Kerala State Financial Enterprise(KSFE) is the
renowned chit fund company administered by Kerala State Government
deals in the principal business of Chit Scheme. KSFE Is a Miscellaneous
Non-Banking Finance Company, fully owned by the Government of Kerala
with the objective of providing an alternative to the public from the private
chit promoters in order to bring in social control over the chit fund
business, so as to save the public from the clutches of unscrupulous fly-by-
night chit fund operators. It has been registering impressive profits every
year, without fail since its inception. KSFE pays to the Government of
Kerala crores of rupees every year by way of Guarantee Commission,
Service Charges and Dividend. A person can enroll in a chitty either by
visiting the Branch or through the agents of KSFE. Chitty is the main
product of KSFE fully governed by the provisions of Central Chit Fund Act
1982. The installment per month for chitties range from Rs. 1,000 to Rs.
5,00,000 and the usual duration of chitties are 30 months, 40 months, 50
months, 60 months and 100 months. The total of the periodic subscription,
called the chitty amount, will be given out as “prize money” to the person
who bids by allowing for the maximum reduction in the prize money. The
maximum reduction possible is 25% as per the prevailing Chitty Act and if
there are more than one subscriber interested in bidding at 25% reduction,
the numbers of the such bidders will be put to a draw.
! !209
Thus each subscriber gets an opportunity to receive the prize money once
during the tenure of the chitty. All the promoters have to contribute the
periodic subscription till the end of the chitty. KSFE NRI Chitties are
specifically designed for the NRI community. (source: http://ksfe.com)
A chit fund is a type of rotating savings system practiced in India. It can

have many schemes. Chit fund schemes are formally organized by financial
institutions, or informally among friends, relatives, or neighbors. A chit
fund comprises a group of members, called subscribers. The subscribers
contributes an equal installment every month to the chit fund for a fixed
period. An open auction is conducted to determine the lowest sum a
subscriber is willing to take that month. The surplus is distributed to the
other members. for example if 10 members contribute Rs. 100, the total
fund if auctioned for say Rs. 90, then the surplus Rs. 10 is distributed
between remaining 9 subscribers after paying fees to the organizer. The
subscriber who won the auction was able to access a lumpsum amount and
the others benefited by getting their share out of the surplus. The process
repeats, distributing the auction amount to one member each month.
Every subscriber, including the ones who took their share in a previous
month, continue paying the monthly installments.
Thus a chit fund can acts as a both a borrowing scheme, because

subscribers are able to access large sums of money on winning auction bid
and It also acts as a savings system, because each subscriber may retrieve
a large sum in the future while receiving their share of the surpluses.
Some chit funds are conducted as a savings scheme for a specific purpose
and has a specific end date that coincides with some festival such as
Diwali, New Year etc. These special purpose chits are becoming popular
amongst jewellery shops, kitchenware shops, etc. to promote their
products. Subscribers deposit their installment for 11 months and these
sellers contribute in the deficit for meeting the full value of the product
while buying by the subscriber in the 12th month.
With the advent of ecommerce in India, chit funds have also started going
online. Online chit funds conduct auctions, and subscribers can pay their
monthly dues and receive the prize amounts online through online
transactions, including electronic fund transfers
! !210
Chit Funds can be misused by its promoters and there are many several
instances of people misusing such Ponzi schemes and then absconding with
investor’s money. Such company tries to lure investors with promise of
handsome return on their investment in a short span of time.
In a recent chit fund scam at least Rs. 20,000 crore of deposit-holders’

money is at risk after the sudden closure of the chit fund firm. Securities
and Exchange Board of India (SEBI), has already initiated a probe into the
recent chit fund scam. RBI had barred the chit fund entities from accepting
deposits from the public in 2009. If unincorporated entities are found
accepting public deposits, they were liable for criminal action.
Both organizers and subscribers in chit funds are exposed to credit risk.
Any default in making periodical payments by the subscribers might impact
both the organizers and subscribers. Some organizers insist on sureties for
future liabilities from subscribers who win auctions.
Here again an investor must be cautious before investing to check the

credentials of the fund manager and the previous percentage of default
and the returns.
! !211
Shriram Chits
!
Source: https://shriramchits.com
Shriram Chits is one of the leading chit funds company in the Chit Funds
industry propagating the message of small savings and responsible money
management It has already created immense social capital. As per its
website details it has already empowered over 40 lakh families through
prosperity, disbursed over Rs. 50,000 crores to chit Subscribers and Small/
Medium Enterprises. through 700 Branches.
The benefits of chits given on their website https://shriramchits.com is as

follows:
BENEFITS OF CHITS
General Information
CHITS provides a good source of finance for different type of people viz.,
small investors, businessmen, small scale industrialists etc. CHITS is a
good means of savings for any contingency requiring substantial amount.
It serves all persons whether they desire for savings or borrowing to meet
extraordinary expenses on special occasions like Marriages, Construction of
houses etc.,
! !212
Adequate care is necessary to choose a suitable Group. The selection of a

particular Group, largely depends on the subscriber's capacity to provide
surplus funds month after month from his normal income for this purpose.
This aspect is very important for the subscriber as well as the company's
point of view to avoid any embarrassment at the time of releasing the prize
money or in releasing chit instalments month after month.
1. What is a Chit?
It is a CONTRACT between the foreman, as the Promoter is called, and the
subscribers, who join voluntarily. It is a FINANCIAL SYSTEM under which
the periodical and regular savings of a group of subscribers are made
available to each subscriber, a SPECIFIED AMOUNT every month
(instalment) for a SPECIFIED PERIOD. The Pooled funds every month are
offered to the subscribers at monthly AUCTIONS and the subscriber who
BIDS for the highest DISCOUNT is declared the PRIZE WINNER and given
the PRIZE AMOUNT on proper security. A Prized subscriber also should
continue to pay the subscriptions till the termination of the chit. The
amount foregone as discount, less foreman?s commission is distributed
among the subscribers as dividend.
2. What is a Chit group?

A Chit group refers to a specified number of members agreeing to
subscribe a specified amount for a specified period. For example, 40
members, 40 months, Rs. 500 a month. The number of members and the
number of months are to be the same.
3. Who is a foreman?
Any person under the Act responsible for the conduct of the chit and
includes any Person, such as branch manager, discharging his functions.
4. Is the contract of the subscribers with the foreman valid for an

indefinite period?
No. It is valid only for the duration of a CHIT GROUP and until the liabilities
of subscribers to foreman or vice versa are discharged or paid in full.
! !213
5. What are the benefits of chit Subscribers?
a. To save in small amounts to receive a lump sum during the period of

chit.
b. To borrow the future savings in advance. Some subscribers join chit

funds to borrow and others to save.
6. What is Chit agreement?
The Chit agreement is a contract between the foreman and the individual
subscribers to a chit group. It is a set of bye-laws or regulations dealing
with the procedure for the conduct of chits. It will be signed in duplicate,
duly witnessed. The chit agreements shall contain the name and address of
the subscriber, the number of tickets allotted to him, the number of
instalments and the instalment amount payable, the interest/penalty for
delayed payment, the probable date of commencement of chit and its
duration, the manner of deciding the prize winner at each instalment, the
maximum discount to be foregone at each instalment, the mode and
proportion of dividend and foreman?s commission, the date, time and
place of auction, the instalment at which the foreman is to get the chit
amount, the name of the bank, the security to be furnished by prized
subscriber etc., Though each subscriber is supposed to sign the chit
agreement, in practice, each subscriber signs a declaration in the
application form that he has read and understood the terms and conditions
of the Chit Agreement. The declaration of all the subscribers are detached
from the application form, pasted in a piece of paper and filed with the
registrar.
7. How are the subscribers enrolled for a group?
The subscribers have to fill in an application form furnishing particulars of

their names, residential and office addresses, approximate gross monthly
salary, names of nominees and their relationship to them. They also have
to sign the declaration that they have read and understood the terms &
conditions of the Chit Agreement.
! !214
Benefits of CHIT
1.1 A good source of Finance for all contigencies.
1.2 Way of saving or borrowing to meet Special expenses like marriage or

building or purchase of a house or flat
1.3 Source of finance for businessmen
2. DETAILS OF GROUPS AVAILABLE ETC.,
2.1 Details of groups available and other information as to the mode of

auction and nature of security required are available the branch.
2.2 The security indicated will normally apply for one chit .If the
subscriber holds more than one prized chit in the same branch or other
branches of the Company, the combined future liability will be taken into
account for the purpose of security.
2.3 The subscriber may select a suitable group depending upon his
capacity to pay monthly and also on his ability to provide adequate
security, immovable or otherwise.
2.4 Subscribers may seek the guidance or the branch in all matters.
2.5 Right of admission to chits is reserved by management.
3. REMITTANCE OF SUBSCRIPTION
3.1 Subscribers must pay the monthly installments on or before the due
date either by cash or cheque or D.D to pariticipate in the auction. Cheques
should have been encashed before the date of the auction for eligibilty to
participate in the auction.
3.2 Every month, immediately after the auction (within 7 days) intimation
cards containing details of bid amount in the last auction, monthly
installment payable, any payable du, date of next auction, due date for
payment etc., are send to the subscribers. no-receipt of intimation card will
not be accepted as an excuse for non-payment or belated payment.
! !215
3.3 Failure to remit instalments in time by both prized and non-prized

subscribers will entail forfeiture of dividend besides being charged interest
as detailed in chit agreement. In respect of non-prized subscribers, default
in payment of monthly subscription will disqualify them from participating
in the auction.
3.4 Cheques form outstation subscribers drawn on any bank which is a

member of Banker's clearing house only will be accepted at par.
3.5 If cheques given are dishonoured, future subscription will be accepted

only in cash. Penalty charges by the Bank in respect of such dishonoured
cheques will be recovered from the subscriber.
3.6 To facilitate subscribers, monthly installments are being accepted in

all branches and Service Centres in Tamilnadu even if the chit does not
belong to that branch. Such a facility is only gratuitous. The Company
however will not be held responsible if the remittance details are not
received by the branch in which the chit is held from the other branch or
service centre where remittance is made before the auction date.
3.7 The facility of payment of subscriptions in a branch other than the

branch where the chit is held, will not be available to defaulted prized
subscribers against whom awards have been passed by the Deputy
Registrar of Chits. If however such subscribers pays such amount in "other
branch" such amount will be treated as only as "on account" and not
relating to any particular instalment.
3.8 Subscribers are advised to give only "Account Payee" cheques in the
name of the Company. Issuing blank cheques or Self cheques to our
collection agents should be strictly avoided.
3.9 In the event of a prized subscriber receiving a notice under Sec.33

even though he had remitted the uptodate instalment in another branch of
the company, it is the duty of the subscriber to produce such receipt to the
branch where his chit is held and reconcile the matter.
! !216
4. PROCEDURE FOR AUCTION
4.1 Eligibility for prize money is determined by auction. In all auctions

commencing from the 2nd instalment, subscribers can bid upto a
maximum of 40% only. if more than one subscriber offers identical
discount, the prized subscribers will be determined by lot. The bid amount
shall be in multiples of Rs. 50. the minimum discount foregone shall be not
less than the foreman's commission for the group.
4.2 The duration of auction will be 5 minutes. Specific time is assigned for
each group on a specific date. If the auction date falls on a holiday or if
owing to unforeseen cause the date and time have to be changed, such
change of time/date will be notified individually and also in the branches.
4.3 Subscribers can participate either in person or through a duly

authorised representative. Written authorisation is necessary.
4.4 The subscribers can also communicate offers in writting in a closed

cover superscribing as: "Bid offer to be opened at the time of auction only,
for Group No.......... auction on ..............."
4.5 Telephonic/Telegraphic offers are not accepted. Original receipt should

be produced at the time of auction, if cash payment of subscription is made
on the date of auction.
4.6 The request for offer/tender/Inclusion in lot should be presented only

at the branch in which chit is held.
4.7 Whenever a non-prized subscriber has given his chit under lien to
another prized ticket, such non-prized subscriber can participate in auction
only when the liabilities of the prized ticket are fully paid or alternative
acceptable security is offered and the lien is lifted.
! !217
5. Subscribers who had given standing offers should ascertain the

trend of bidding and modify their offers if necessary.
5.1 Distribution of Dividend
5.2 5% of the chit value shall be deducted from the amount towards
foreman commission and the balance distributed as dividend equally
among all eligibile subscribers in all chts started after October 2008. The
dividend will be adjusted in subscription for the next instalment
As per the present policy four groups with 30,40,50 and 60 months
duration will be floated by our branches.
6. RELEASE OF PRIZE MONEY
6.1 The prize money will be paid to the successful subscriber on a

working day before the next auction date on the basis of adequate and
satisfactory security, offered to cover the combined future liability of all
chits held by the subscriber in all branches of the company.
6.2 Prize money will be released by "A/c Payee Cheques" only. If payment
is desired through Bank draft by outstation subscribers, it will be obtained
deducting D.D Commission provided a branch of the bank with whom the
company is having account is functioning there
6.3 With effect from 01-06-2007 'Service Tax' is leviable from the Prize
Money received by every Prized subscriber at the rate of 12.36% on the
foreman's commission for the Prized Chit. The rate is liable to change as
per government orders.
7. CHANGE OF ADDRESS
Any change in the address of a subscriber prized and non-prized and

gaurantors in the case of prized chits should be promptly intimated to the
Foreman under acknowledgement. In the absense of such proper
intimation the Foreman is not responsible for non-receipt of any intimation
or notice from the Foreman in connection with their chit.
! !218
8. SUGGESTIONS
Subscribers are advised to keep watch over the trend of bidding every
month and at a convenient point of time, they can bid the chit. There are
opportunities for investing the Prize Money in attractive Company deposits
to ensure a good return. Shriram Investments Advisory Division will be
able to offer you valuable guidance in respect of acceptance of deposits by
Shriram Group Companies and subscribers can avail their free service
without any obligation.
9. GENERAL
The above information is indicative of the broad procedure followed. For all
Purposes, the provisions in the Chit Funds Act, 1982 the Rules framed
there under and the Chit agreement will be final. Chit branches will provide
you with all information required. Sometimes you may face certain
difficulties or grievances against the branch. You may refer such cases to
the concerned Divisional/Regional Manager/Zonal Chief Executive for
immediate attention. Still if you find any difficult you may write to General
manager.
5.7 Summary
The Company deposits , Nidhis and Chit funds are the alternatives
available with the investors to save there money in expectation of varying
returns.
Deposits from the public are an important mode of finance for Companies
to do their business. A Nidhi company is incorporated with the object of
benefit. Chit funds plays an important role in the financial development of
people by providing easier access to credit to the needy.
The provisions of Companies Act, 2013 and Companies (Acceptance of

Deposits) Rules, 2014 regulate various aspects of acceptance of deposits
from the public such as ceiling of total deposits, advertisement for seeking
deposits, acceptance and repayment of deposits by Companies.
! !219
Banks, including co-operative banks, can accept deposits. Non-bank

finance companies, which have been issued Certificate of Registration by
RBI with a specific licence to accept deposits, are entitled to accept public
deposit.
The deposits made by investors for a fixed period with manufacturing

companies, financial institutions and Non-Banking Finance Companies
(NBFCs) are called as company fixed deposits.
The deposit acceptance activities of housing finance companies are

regulated by National Housing Bank. No housing finance company shall
accept or renew public deposits unless the housing finance company has
obtained minimum investment grade rating for its fixed deposits from any
one of the approved rating agencies, at least once a year and a copy of the
rating is sent to the National Housing Bank and it is complying with all the
prudential norms. Every housing finance company soliciting public deposits
shall comply with the provisions of the Non-Banking Financial Companies
and Miscellaneous Non- Banking Companies (Advertisement) Rules, 1977.
Nidhi means a company which has been incorporated with the object of
benefit. They are also known as Permanent Fund, Benefit Funds, Mutual
Benefit Funds and Mutual Benefit Company
The primary object of Nidhis is to carry on the business of accepting

deposits and lending money to members. Only individuals can be Members.
Bodies Corporate or Trusts are not admitted as Members. A Nidhi company,
is one that belongs to the non-banking Indian finance sector and is
recognized under section 406 of the Companies Act, 2013. Their core
business is borrowing and lending money between their members. They
are regulated by Ministry of Corporate Affairs. Reserve Bank of India is
empowered to issue directions to them in matters relating to their deposit
acceptance activities.

by providing easier access to credit to the needy. It is one of the main
parts of the unorganized money market industry. Chit fund companies are
a category of Non-Banking Financial Companies (NBFC). The Chit funds are
exempt from being registered with the Reserve Bank of India. The
regulator of chit funds is the Registrar of Chits who is appointed by the
! !220
respective state governments under Section 61 of Chit Funds Act, 1982.

The Reserve Bank of India has allowed nonresident Indians to subscribe to
chit funds without limit on condition that they cannot take the money out
of the country, opening a new avenue to boost foreign currency inflows.
The Chit Funds business is regulated by Chit Fund Act, 1982. Chit funds are
legal under the Chit Funds Act, 1982, which is a central act but
administered by state governments.
1. Explain the provisions of Companies Act 2013 for acceptance of deposits

by companies.
2. Explain the RBI guidelines in acceptance of deposits by NBFCs.
3. Are all NBFCs are not entitled to accept public deposits?
4. What are the salient features of NBFC regulations which the depositor
may note at the time of investment?
5. What precautions should a depositor take before placing deposit with an

NBFC?
6. What is the role of Company Law Board (NCLT) in protecting the interest
of depositors? How can one approach it?
7. The Consumer Court plays useful role in attending to depositors

problems. Can one approach Consumer Forum, Civil Court, CLB
simultaneously?
8. What is the liquid assets requirement for the deposit taking companies?
9. Where are these assets kept? Do depositors have any claims on them?
10.What are Company Fixed Deposits? What are the benefits of Company
Fixed Deposits?
11.Explain the provisions of acceptance of deposits by Housing Finance

Companies?
! !221
12.What are the primary object of Nidhis nd who regulates Nidhi

companies?
13.Explain the provisions of acceptance of deposits by a Nidhi company.
14.Explain the provisions of Lending of money (loans) by Nidhi?
15.What are Chit funds and who regulates chit funds?
16.Explain the chit fund rotating savings system practiced in India.
17.What are the benefits of Chit fund?
1. According to the definition given under section 2(31) of the Companies

Act, 2013, read with Rule 2(c) of Companies (Acceptance of Deposits)
Rules, 2014 the term ‘deposit’ includes any receipt of money by way of
deposit or loan or in any other form, by a company, but does not include
such categories of amount as may be prescribed in consultation with the
RBI.
a. True
b. False
2. According to section 73 of the Companies Act, 2013, no company shall

invite, accept or renew deposits from the public except in a manner
provided under Chapter V of i.e Acceptance of Deposits by Companies of
Companies Act, 2013. However this provision with respect to the
acceptance or renewal of deposit from public will NOT apply to:
a. Banking company
b. Non- banking financial company as defined in the Reserve Bank of
India Act, 1934
c. Housing finance company registered with the National Housing Bank
established under the National Housing Bank Act, 1987
d. All of the above
! !222
3. Housing finance company registered with the National Housing Bank

established under the National Housing Bank Act, 1987 are also
permitted to accept deposits. No housing finance company shall repay
any public deposit within a period of how many months from the date of
its acceptance?
a. 3
b. 6
c. 9
d. 12
4. A Nidhi company, is one that belongs to the non-banking Indian finance

sector and is recognized under section 406 of the Companies Act, 2013.
Their core business is borrowing and lending money between their
members. Which of the following statement relating to Nidhi companies
is NOT correct?
a. Nidhi shall, within a period of one year shall have two hundred
members
b. Nidhi company can issue preference shares
c. No Nidhi shall have any object in its Memorandum of Association
other than the object of cultivating the habit of thrift and savings
amongst its members
d. Every Company incorporated as a “Nidhi” shall have the last words
‘Nidhi Limited’ as part of its name.
5. Any person under the Chit Fund Act,1982 responsible for the conduct of
the chit and includes any Person, such as branch manager, discharging
his functions is known by which of the following names?
a. Watchman
b. Team Leader
c. Foreman
d. Arbiter
A
Ans: 1. (A), 2. (D),3. (A), 4. (B), 5. (C)
! !223
5.8 References
1. Companies Act 2013
2. Nidhis Rules, 2014
3. Chit Fund Act 1982
4. Websites of companies, Nidhis and Chit funds
5. RBI and NHB website
6. MCA website
7. Company Law by Dr. G.K. Kapoor and Dr. Sanjay Dhamija
8. In the Wonderland of Investment (FY 2018-19) by A. N Shanbhag and

Sandeep Shanbhag
9. Chit Funds in India: Analysis of Regulatory Framework by Ankeeta

Gupta
10.Chit Fund Industry Emerging Trends by K.P. Sumedhan
11.Behavioral Finance in India A Study of Chit Funds by Raji Reddy

Lachagari
12.Ajit Prakashan's Chit Fund Act, 1982 & Maharashtra Chit Fund Rules
2004 by Adv. Sudhir J. Birje
13.https://en.wikipedia.org
14.https://www.legalraasta.com
15.https://enterslice.com/learning
! !224
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !225
COLLECTIVE INVESTMENT SCHEMES
Chapter 6
Collective Investment Schemes
Objectives:
This chapter will help you understand basic objectives of investing in

collective investment schemes, the structure, schemes and benefits of
investing in Mutual funds as well how to evaluate the performance of
Mutual Funds.
Structure:
6.1 Introduction
6.2 What is a Mutual Fund
6.3 Structure of Mutual Fund
6.4 Mutual Fund Schemes and Objectives
6.5 Mutual Fund Distribution Channels
6.6 Net Asset Value (NAV)
6.7 Investment Plans
6.8 Investment Options
6.9 Taxation on Mutual Fund schemes
6.10 Advantages of investing in Mutual Funds
6.11 Summary
6.13 References
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6.1 Introduction
A Collective Investment Scheme(CIS) involves collecting money from

different investors inorder to invest this money in the financial markets to
earn income which is distributed to the investor after deduction of
expenses ad tax. The capital appreciation is also shared by the investors. A
Collective Investment Scheme involves several individuals come together
to pool their money for investing in a particular asset(s) and for sharing
the returns arising from that investment. CISs are regulated by the SEBI
under SEBI (Collective Investment Scheme) Regulations, 1999. The SEBI
(Collective Investment Schemes) (Amendment) Regulations, 2000 gave a
new expression of ‘collective investment scheme’ and said ‘collective
investment scheme’ shall have the same meaning as assigned to it under
section 11AA of the Securities and Exchange Board of India Act, 1992.
According to section 11AA of Securities and Exchange Board of

India Act, 1992 any scheme or arrangement which satisfies the following
conditions shall be a collective investment scheme:
1. the contributions, or payments made by the investors, by whatever

name called, are pooled and utilized solely for the purposes of the
scheme or arrangement;
2. the contributions or payments are made to such scheme or

arrangement by the investors with a view to receive profits, income,
produce or property, whether movable or immovable from such scheme
or arrangement;
3. the property, contribution or investment forming part of scheme or

arrangement, whether identifiable or not, is managed on behalf of the
investors;
4. the investors do not have day to day control over the management and
operation of the scheme or arrangement.
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A registered Collective Investment Management Company is

eligible to raise funds from the public for a particular Scheme
subject to following conditions:
• No person other than a Collective Investment Management Company

which has obtained a certificate from SEBI shall carry on or sponsor or
launch a collective investment scheme.
• As per Securities Laws (Amendment) Act, 2014 any pooling of funds

under any scheme or arrangement, which is not registered with SEBI,
involving a corpus amount of one hundred crore rupees or more shall be
deemed to be a collective investment scheme. The new law gave SEBI
the power to search and obtain information and regulate even such
unregistered schemes
However, the following activities shall not be deemed to be a

collective investment scheme:
a. acceptance of deposits by companies under Companies Act 2013 or by

Non-Banking Financial Companies as defined in Reserve Bank of India
Act, 1934
b. acceptance of funds by Chit Funds in terms of the Chit Funds Act, 1982
c. acceptance of funds by companies declared as Nidhi companies under

Companies Act 2013
d. contracts of insurance under the Insurance Act, 1938
e. any scheme of the employer as per Employees’ Provident Fund and

Miscellaneous Provisions Act, 1952
f. arrangements of cooperative societies under the Cooperative Societies

Act, 1912
g. any scheme under Securities and Exchange Board of India (Mutual

Funds) Regulations, 1996
h. any other scheme or arrangement specifically exempted by SEBI
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• For the purpose of determining whether the collective investment

management company is a fit and proper person, SEBI may take into
account the criteria specified in Schedule II of the Securities and
Exchange Board of India (Intermediaries)Regulations, 2008.
• Every Collective Investment Management Company shall be responsible

for managing the funds or properties of the collective investment scheme
on behalf of the unit holders.
• Every Collective Investment Management Company shall also exercise

due diligence and care in managing assets and funds of the collective
investment scheme and remain liable to the unit holders for its acts of
commission or omissions.
• No collective investment scheme shall be launched by the Collective

Investment Management Company without obtaining rating from a credit
rating agency.

Investment Management Company without getting the collective
investment scheme appraised by an appraising agency.

Investment Management Company unless such collective investment
scheme is approved by the Trustee.
• Collective Investment Management Company shall launch only close

ended collective investment schemes and the duration of the collective
investment schemes shall not be of less than three calendar years.
• Collective Investment Management Company shall obtain adequate

insurance policy for protection of the collective investment scheme]e
property.
• No collective investment scheme shall provide guaranteed or assured

returns. However an indicative return may be indicated in the offer
document only, if the same is assessed by the appraising agency and
expressed in monetary terms.
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• Advertisements in respect of every [collective investment scheme shall

be in conformity with the Advertisement Code as specified in SEBI
regulations.
• The Collective Investment Management Company shall before launching

any collective investment scheme file a copy of the offer document of the
collective investment scheme with SEBI.
• The offer document and advertisement materials shall not be misleading

or contain any statement or opinion which are incorrect or false
• No collective investment scheme shall be open for subscription for more

than 90 days
• The Collective Investment Management Company shall issue to the

applicant whose application has been accepted, unit certificates as soon
as possible but not later than six weeks from the date of closure of the
subscription list.
• If the units are issued through a depository, a receipt in lieu of unit

certificate will be issued as per provisions of Securities and Exchange
Board of India (Depositories and Participants) Regulations, 1996 and
byelaws of the depository
• The units of every collective investment scheme shall be listed

immediately after the date of allotment of units and not later than six
weeks from the date of closure of the collective investment scheme on
each of the stock exchanges as mentioned in the offer document
Full provisions and latest update can be referred under SEBI (Collective
Investment Scheme) Regulations, 1999.
Before investing into any such collective investment schemes,

investors should ensure that such Collective Investment Management
Company is registered with SEBI. There are various instances of complaints
by investors who have invested in Collective Investment Schemes
promising higher returns but failed to provide any return on the
investments and including the repayment of principal amount. This was the
very reason Government felt the need to protect the investors and decided
that an appropriate regulatory framework for regulating entities which
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issue instruments like agro bonds, plantation bonds etc., should be put in
place. Subsequently SEBI introduced the SEBI (Collective Investment
Scheme) Regulations, 1999 to regulate the entities connected with the
Collective Investment Scheme and to safeguard the interest of the
depositors. After the Sahara/Sharada scams in 2013, SEBI modified the
definition of CIS to include any scheme floated by any person/company
with corpus of more than Rs. 100 Crore as a deemed to be Collective
Investment Scheme. The Central government in coordination with State
Government and regulators such as RBI, SEBI, IRDA, NHB, PFRDA are
always looking out to strengthen the Collective Investment Schemes
Regulations in order to control the incidents of unauthorized acceptance of
deposits by unscrupulous entities through glamorous Deposit Taking
schemes.
6.2 What is a Mutual Fund?
The definition of CIS excludes mutual funds. However SEBI has

defined Mutual Funds in SEBI (Mutual Fund) Regulations, 1996 as
“a fund established in the form of a trust to raise monies through the sale
of units to the public or a section of the public under one or more schemes
for investing in securities including money market instruments or gold or
gold-related instruments or real estate assets.”
Mutual fund is similar to a collective investment scheme (CIS)

which pools the savings and invests them to generate returns. While
mutual fund invests in securities, CIS invests only in plantations,
real estate and art funds. Securities‖ has the meaning assigned to it in
section 2 of the Securities Contracts (Regulation) Act, 1956.
Securities include any of the following:
1. shares, scrips, stocks, bonds, debentures, debenture stock or other

marketable securities of a like nature in or of any incorporated company
or other body corporate
2. derivative
3. units or any other instrument issued by any collective investment

scheme to the investors in such schemes
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4. security receipt as defined in clause (zg) of section 2 of the

Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002
5. units or any other such instrument issued to the investors under any
mutual fund scheme
6. Government securities
7. such other instruments as may be declared by the Central Government

to be securities
8. rights or interest in securities
Mutual fund is a collective investment scheme which mobilises the savings

from the savings of a large number of investors for collective investments
in diversified portfolio, with the objective of attracting yields and
appreciation in their value. These investors may be retail or institutional in
nature. Mutual fund is a “trust” to mobilize money from investors, to invest
in different markets and securities, in accordance with the common
investment objectives agreed upon, between the mutual fund and the
investors. The income/gains generated from this collective investment is
distributed proportionately amongst the investors after deducting certain
expenses, by calculating a scheme’s Net Asset Value(NAV).
The Securities and Exchange Board of India (Mutual Funds)

Regulations, 1996 defines a mutual fund as a ‘a fund established in
the form of a trust to raise money through the sale of units to the public or
a section of the public under one or more schemes for investing in
securities, including money market instruments or gold or gold related
instruments or real estate assets’.
A mutual fund is required to be registered with Securities and Exchange

Board of India (SEBI). Mutual fund investment is specifically preferred by
those who are not well versed with investing in capital market, but want to
entrust their money to an expert who can professionally manage their
money.
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The primary role of mutual fund is to assist investors in earning an income

or building their wealth, by participating in the schemes suiting investment
objectives. Mutual funds mobilize different pools of money based on
different investment preferences and life goals of investors. Each such pool
of money is called a mutual fund scheme and restricts its investment in the
agreed market and securities. Mutual fund scheme may collect money from
investors during a pre declared period or the investor may be allowed to
invest any time.
The money that is collected from investors, is ultimately used directly or

indirectly, for investing in various projects which in turn leads to economic
growth. On behalf of large investor, the mutual funds keeps a check on the
operations corporate governance and ethical standards of the investee
company, and periodically rebalances its portfolio.
Mutual fund is thus a mechanism for pooling the resources by

issuing units to the investors and investing funds in securities in
accordance with objectives as disclosed in offer document. Investments in
securities are spread across a wide cross-section of industries and sectors
in order to reduce the risk in investing. Diversification of investment
reduces the risk. Mutual fund issues units to the investors in accordance
with quantum of money invested by them. The returns/gains are shared by
the investors in proportion to their investments.
In 1868, Robert Fleming established the first investment trust named

Foreign and Colonial Investment Trust in UK, to manage the finance of the
affluent classes of Scotland. The Mutual Fund became popular in many
counties because it offered various schemes and options to invest.
The mutual fund concept was introduced in India for the first time by
setting up of UTI in 1963. UTI commenced with the launch of the Unit
Scheme 1964 (US-64), the first open-ended scheme. Master share was the
first close-ended scheme launched by UTI. UTI also launched the first
Indian offshore fund for overseas investors in 1986.This fund was listed on
the London Stock Exchange (LSE). In 1987.
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In early 1990s, Government allowed public sector banks and institutions to

set up mutual funds. Public sector banks floated mutual funds e.g. SBI
Mutual Fund and Canbank Mutual Fund were set up as trusts under the
Indian Trust Act, 1882. Later Insurance companies also established
separate subsidiaries for mutual funds. Various regulatory guidelines wee
issued by RBI and Government of India. All these guidelines were
consolidated by the SEBI (Mutual Fund) Regulations, 1996. Private and
foreign players were allowed to enter the mutual fund industry. The flow of
funds increased sharply there on.
After the enactment of SEBI Act 1992, SEBI formulates policies and
regulates the mutual funds to protect the interest of the investors. SEBI
had first notified the Securities and Exchange Board of India (Mutual
Funds) Regulations, 1993, which were revised in 1996 and have been
amended thereafter from time to time. All mutual funds whether promoted
by public sector or private sector entities including those promoted by
foreign entities are governed by SEBI.
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6.3 Structure of Mutual Fund
SEBI has stipulated a 3-tier legal structure which has inherent checks and
balances to protect the interests of the investors. A mutual fund is set up
in the form of a trust, which has sponsor, trustees, Asset Management
Company (AMC) and custodian.
The mutual fund trust is created by one or more Sponsors who is

like promoter of a company. Sponsors comprise the first tier of the
Mutual Fund. A mutual fund shall be constituted in the form of a trust
under the Indian Trust Act, 1882 by the Sponsor and the instrument of
trust shall be in the form of a deed, duly registered under the provisions of
the Indian Registration Act, 1908 executed by the sponsor in favour of the
trustees named in such an instrument. The Sponsor should apply for
registration in form A prescribed under Schedule I of SEBI (Mutual Funds)
Regulations 1996 for registration of Mutual Fund with SEBI. The main
objects of the memorandum of the sponsor company should permit it to
carry on mutual fund activities. SEBI will grant certification of registration
as a mutual fund once all the requirements have been complied with and a
requisite fee as per Second Schedule of SEBI Regulations has been paid.
Sponsor should have the following criteria’s fulfilled
1. Sound track record and general reputation of fairness and integrity in all
his business transactions.
"Sound track record" shall mean the sponsor should
a. Be carrying on business in financial services for a period of not less

than five years;and
b. The net worth is positive in all the immediately preceding five years;
and
c. The net worth in the immediately preceding year is more than the
capital contribution of the sponsor in the asset management
company; and
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d. The sponsor has profits after providing for depreciation, interest and
tax in three out of the immediately preceding five years, including the
fifth year
2. The applicant is a fit and proper person
3. In the case of an existing mutual fund, such fund is in the form of a

trust and the trust deed has been approved by the Board
4. The sponsor has contributed or contributes atleast 40% to the net worth
of the asset management company
5. The sponsor or any of its directors or the principle officer to be

employed by the mutual fund should not have been guilty of fraud or
has not been convicted of an offence involving moral turpitude or has
not been found guilty of any economic offence
6. Should establish trust and appoint trustees to act as trustees for the
mutual fund in accordance with the SEBI regulations
7. Should ensure appointment of asset management company to manage

the mutual fund and operate the scheme of such funds in accordance
with the SEBI regulations;
8. Should ensure appointment of custodian in order to keep custody of the
securities or gold and gold related instrument or other assets of the
mutual fund held in terms of SEBI regulations, and provide such other
custodial services as may be authorised by the trustees
Mutual funds are constituted as Trusts which comprises the second tier
of a Mutual Fund. Trusts are governed by the Indian Trusts Act, 1882. The
Trust acts through its trustees. The operations of the mutual fund trust are
governed by a Trust Deed, which is executed between the sponsors and the
trustees. The trustees are vested with the general power of
superintendence and direction over AMC. They monitor the performance
and compliance of SEBI Regulations by the mutual fund Investors are the
beneficiaries who invest in various schemes of mutual funds in expectation
of returns and capital appreciation. The trustees of the mutual fund hold its
property for the benefit of the unitholders. SEBI Regulations require that at
least two-thirds of the directors of trustee company or board of trustees
must be independent i.e. they should not be associated with the sponsors.
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The trustees shall have a right to obtain from the asset management
company such information as is considered necessary by the trustees. The
trustees shall not be held liable for acts done in good faith if they have
exercised adequate due diligence honestly.
Credentials for being appointed as trustees:
No trustee shall initially or any time thereafter be appointed as a Trustee

without prior approval of SEBI. A Trustee should possess the following
credentials:
a. he is a person of ability, integrity and standing; and

b. has not been found guilty of moral turpitude; and
c. has not been convicted of any economic offence or violation of any
securities laws; and
d. has furnished particulars as specified in Form C.
No asset management company and no director (including independent

director), officer or employee of an asset management company shall be
eligible to be appointed as a trustee of any mutual fund.
No person who is appointed as a trustee of a mutual fund shall be eligible

to be appointed as a trustee of any other mutual fund.
Two-thirds of the trustees shall be independent persons and shall not be
associated with the sponsors or be associated with them in any manner
whatsoever
The trustees shall ensure before the launch of any scheme that the asset
management company, has:
a. systems in place for its back office, dealing room and accounting;
b. appointed all key personnel including fund manager(s) for the

scheme(s)
c. appointed auditors to audit its accounts
d. appointed a compliance officer who shall be responsible for

monitoring the compliance of the SEBI Act, rules and regulations,
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notifications, guidelines, instructions, etc., issued by the SEBI or the

Central Government and for redressal of investors grievances
e. appointed registrars and laid down parameters for their supervision
f. ensure that the trust property is properly protected, held and

administered.
g. prepared a compliance manual and designed internal control

mechanisms including internal audit systems
h. specified norms for empanelment of brokers and marketing agents
i. obtained, prior in principle approval from the recognised stock

exchange(s) where units are proposed to be listed
j. hold meeting of trustees more frequently, consider the reports of the

independent auditor and compliance reports of asset management
company at the meetings of trustees for appropriate action
k. periodically review the investor complaints received and their

redressal by the AMC.
l. prescribe and adhere to a code of ethics by the Trustees, asset

management company and its personnel
m. file half-yearly reports to SEBI
Asset Management Company (AMC) is the third tier of a Mutual

Fund which is responsible for day to day operations of the Mutual
Fund. It is considered as a operational arm of the Mutual Fund. AMC is
required to execute an investment management agreement with the
Trustees. This agreement determines the operations path for the AMCs.
SEBI Regulations require that 50% of the directors of AMC must be
independent. The asset management company shall take all reasonable
steps and exercise due diligence to ensure that the investment of funds
pertaining to any scheme is not contrary to the provisions of SEBI
regulations and the trust deed. The asset management company shall
exercise due diligence and care in all its investment decisions. The asset
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management company shall submit to the trustees quarterly reports of

each year on its activities and the compliance with these regulations.
The sponsor or, if so authorised by the trust deed, the trustee, shall
appoint an asset management company, which has been approved by
SEBI.
Eligibility criteria for appointment of asset management company
• sound track record, general reputation and fairness in transactions
• the asset management company is a fit and proper person
• the directors of the asset management company are persons having

adequate professional experience in finance and financial services related
field and not found guilty of moral turpitude or convicted of any economic
offence or violation of any securities laws
• the key personnel of the asset management company have not been
found guilty of moral turpitude or convicted of economic offence or
violation of securities laws or worked for any asset management
company or mutual fund or any intermediary 39[during the period when
its registration has been suspended or cancelled at any time by SEBI
• the board of directors of such asset management company has at least

fifty per cent directors, who are not associate of, or associated in any
manner with, the sponsor or any of its subsidiaries or the trustees
• the Chairman of the asset management company is not a trustee of any

mutual fund
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• the asset management company has a networth of not less than rupees
fifty crore
The AMC is responsible for conducting the activities of the mutual fund
and is required to arrange for the requisite offices and infrastructure,
engage employees, provide for the requisite software, handle advertising
and sales promotion, and interact with regulators and various service
providers.
Restrictions on AMC
The SEBI Regulations provide for various limits to the kind of investments
that are possible in mutual fund schemes as well as aggregate limits for all
schemes of a mutual fund together. AMC are required to adhere to this
limits. The AMC has to buy and sell securities on delivery basis only and
will not invest in the unlisted or privately placed securities .It shall not
advance any loans. Investment in other schemes of the same Mutual Fund
or other Mutual Funds cannot exceed 5 percent of the net asset value of
the scheme. The AMC under all its schemes shall not own more than 10
percent of a company’s paid up capital bearing voting rights. The AMC
scheme shall not invest more than 10 percent of its NAV in investment
grade debt instruments issued by a single issuer. Investment in unrated
debt securities of a single issuer will be limited to 10 percent of its NAV and
the total investments in such securities shall not exceed 25 percent of the
NAV of the scheme. Parking of funds in Short-term deposits with all
scheduled commercial banks shall be limited to 15 percent of the net
assets of the scheme. The total exposure of debt schemes of mutual funds
in a particular sector shall not exceed 25 percent of the net assets of the
scheme. The ELSS requires 80 percent of the ELSS funds should be
invested in equity and equity-linked securities.
The Chief Executive Officer of the asset management company shall

ensure that the mutual fund complies with all the provisions of SEBI
regulations and the guidelines or circulars issued in relation thereto from
time to time and that the investments made by the fund managers are in
the interest of the unit holders and shall also be responsible for the overall
risk management function of the mutual fund.
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Chief Investment Officer (CIO) is responsible for overall investments of

the fund. Fund managers assist the CIO.
Fund Manager: Every scheme should have a fund manager. The fund
managers shall ensure that the funds of the schemes are invested to
achieve the objectives of the scheme and in the interest of the unit
holders.
Securities Analysts support the fund managers through their research

inputs.
Securities Dealers help in putting the transactions through the financial

market.
The fund accountant calculates NAV on a daily basis after closing of

markets, by collecting information about the assets and liabilities of each
scheme
Chief Marketing Officer (CMO) is responsible for mobilizing money

under the various schemes. Direct Sales Team, Channel Managers and
Advertising & Sales Promotion Team support the CMO
Chief Operations Officer (COO) is responsible for the day-to-day

administration and operations of the AMC
Compliance Officer is responsible for the legal compliances and reports

directly to the head of the AMC in order to ensure independence.
Custodian
The custody of the assets of the scheme (securities, gold, gold-related

instruments & real estate assets) is with a Custodian. The Custodian is
appointed by the trustees. A custodian is granted a certificate of
registration to carry on the business of custodian of securities under the
Securities and Exchange Board of India (Custodian of Securities)
Regulations 1996. The sponsor or its associates cannot control 50 percent
or more of the shares of a custodian. If 50 percent or more of the directors
of a custodian represent the interest of the sponsor or its associates, then,
also such that custodian cannot be appointed for the mutual fund operation
unless certain specific conditions are fulfilled. An independent custodian
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ensures holding of securities in the scheme for the benefit of investors.

This is one of the reasons why mutual fund AMCs cannot vanish suddenly
like vanishing companies’ in shares and fixed deposits. The AMC and the
Custodian both operate under the control of the Trustees and thus there
are inbuilt checks and balances on the entire system to protect the
investors from misappropriation of funds, fraud etc. Even if the Sponsor
wants to exit, the business, they need to bring in some other sponsor,
acceptable to SEBI, before they can exit and the new sponsor will be
required to create a new set up acceptable to SEBI.
The custodian needs to accept securities on purchase and give delivery of

for sale transactions of the various schemes of the fund. The custodian is
also responsible to settle all the transactions on behalf of the mutual fund
schemes. The custodian also tracks corporate actions such as dividends,
bonus and rights.
Registrar & Transfer Agent (RTA)
The record of investors may be maintained by the AMC itself, or it can

appoint a Registrar & Transfer Agent (RTA). The appointment of RTA is
done by the AMC. All RTAs need to register with SEBI.
RTA can perform many activities such as processing of purchase and

redemption transactions, receiving funds for purchases and making
payments for redemptions, updating the unit capital of the scheme,
updating the information in the individual records of the investor, keeping
the investor updated with statements related to the investment.
Investors can approach to registrars of respective mutual funds for their
service requests. Computer Age Management Services (CAMS) and Karvy
Computer share are the major service providers.
For e.g. 1. Reliance Mutual Fund
Sponsor Nippon Life Insurance Company / Reliance Capital Limited
Trustee Reliance Capital Trustee Co. Ltd. (RCTC)
Asset Management
Reliance Nippon Life Asset Management Limited (RNAM)
Company (AMC)
Custodian Deutsche Bank AG & CITIBANK NA
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Registrar & Transfer

Karvy Computershare Pvt. Ltd.
Agent (RTA)
For e.g. 2. HDFC Mutual Fund
Sponsor Housing Development Finance Corporation

Limited and Standard Life Investments Limited
Trustee HDFC Trustee Company Limited
Asset Management Company HDFC Asset Management Company Limited

(AMC)
Custodian HDFC Bank Limited, Citibank N.A. and Deutsche

Bank
Registrar & Transfer Agent Computer Age Management Services Pvt.
(RTA) Limited (CAMS),
Auditors are responsible for the audit of accounts of the mutual fund
schemes and needs to be different from the auditor of the AMC.
Distributors are responsible for selling mutual fund schemes to their

clients. A distributor can be empanelled with more than one mutual fund.
Distributors need to pass the NISM-Series- V-A: Mutual Fund Distributors
(MFD) Certification Examination and register with AMFI to get the ARN.
SEBI has mandated AMCs to put in place a due diligence process to
regulate distributors based on their offerings to the clients i.e advisory,
execution only etc.
Investors can choose to change their distributor or go direct without No

Objection Certificate from the existing distributor.
Collection bankers are appointed by the AMC to collect investors money

along application form and required KYC documents.
Payment Aggregators such as Tech Process, Bill Desk etc. facilitate

online payment processing through internet banking bank transfers, credit
card etc for purchase of mutual fund units.
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KYC Registration Agencies (KRA)
PAN No. and KYC documentation are compulsory for mutual fund
investments. SEBI has mandated a unified KYC for the securities market
through KYC Registration Agencies (KRA) registered with SEBI in order to
lessen the burden of multiple KYC formalities. In-Person Verification (IPV)
by a SEBI-registered intermediary such as broker, depository or a mutual
fund distributor is compulsory for all investors.
Central KYC (cKYC)
cKYC refers to Central KYC (Know Your Customer) and is managed by

CERSAI (Central Registry of Securitization Asset Reconstruction and
Security Interest of India), which is authorized by the Government of India
to function as the Central KYC Registry (cKYCR). cKYC act as centralized
repository of KYC records of investors in the financial sector with uniform
KYC norms and enables inter-usability of the KYC records across the sector.
cKYC requires certain additional information over KYC like investor’s
maiden name, mother’s name, FATCA information etc
Once is investor is cKYC complain he is provided with a 14 digit KYC
Identification Number (KIN).
Association of Mutual Funds in India (AMFI), is a mutual fund industry

body that has been created to promote the interests of the mutual funds
industry. Asset Management Companies (AMCs) in India are members of
AMFI.
The AMFI Code of Ethics (ACE) is a sets of standards of good practices to

be followed by the Asset Management Companies in their operations and in
their dealings with investors, intermediaries and the public.
AMFI Guidelines & Norms for Intermediaries (AGNI) is a set of guidelines

and code of conduct for intermediaries such as individual agents, brokers,
distribution houses and banks engaged in selling of mutual fund products
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Which type of Investors can invest in Mutual Funds?
The following is a list of individuals as well as non individuals eligible for

investment in Mutual Funds. However Investors should ensure that that
they are not prohibited by any law governing such entity and any Indian
law from investing in the Scheme and are authorized to purchase units of
mutual funds as per their respective constitutions, charter documents,
corporate / other authorizations and relevant statutory provisions.
Individual Investors
• Resident Indian adult individuals, above the age of 18 can invest, either
singly or jointly (not exceeding three names)
• Minors can invest through their guardians
• Hindu Undivided Families (HUFs) through head of the family (called

“Karta”)
• Non-Resident Indians (NRIs) /Persons of Indian Origin (PIO) resident

abroad
• Foreign investors can invest in equity schemes of MFs registered with

SEBI after completing KYC process.
Non-individual Investors
• Companies registered in India
• Partner(s) of Partnership Firms
• Association of Persons or Body of Individuals, whether incorporated or

not
• Co-operative Societies
• Banks and Financial Institutions
• Trustees of Religious and Charitable Trusts
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• Trustees of private trusts
• Other Mutual Funds registered with SEBI
• Foreign Portfolio Investors registered with SEBI
• International Multilateral Agencies approved by the Government of India
• Army/Navy/Air Force, Para-Military Units and other eligible institutions
• Scientific and Industrial Research Organizations
• Universities and Educational Institutions
The individual as well as non-individual investors have to be KYC

compliant, irrespective of the investment value. Permanent Account
Number (PAN) is also to be provided for all mutual fund investments except
in case of Micro-SIPs i.e. SIPs where annual investment (12 month rolling
or April-March financial year) does not exceed Rs 50,000. AMCs are also
required to comply with the requirements of Foreign Account Tax
Compliance Act (FATCA) and Common by following due diligence process to
identify foreign reportable accounts.
Reporting Standards (CRS) provisions Which type of Investors cannot

invest in Mutual Funds?
• Any individual who is a Foreign National
• Overseas Corporate Bodies (OCBs)
AMCs should provide the following to the investors
• Mutual Funds Schemes other than ELSS remains open for subscription for
a maximum of fifteen days
• Schemes, other than ELSS, need to allot units or refund money within 5
business days of closure of the NFO. In case of delay interest at the rate
of 15 percent p.a. for the period of the delay should be paid to investors.
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• Open-ended schemes, other than ELSS, have to re-open for ongoing

sale/re-purchase within 5 business days of allotment
• Option to receive allotment of mutual fund units in demat account
• Statement of accounts should be sent to investors (In the case of NFO -

within 5 business days of closure of the NFO, In the case of post-NFO
investment – within 5 working days from the day of receiving the receipt
of request from the unitholders, In the case of SIP/STP/SWP within 10
working days of initial transaction and once every quarter for on going
transactions within 10 working days of the end of the quarter, within 5
working days without any cost on specific request from the investor)
• Consolidated Statement of Accounts (across mutual funds based on PAN

of the investor) too is to be sent to the investor for each calendar month
in which there are transactions in the folio
• NAV shall be calculated on the daily basis and disclosed on the website of
AMFI and the mutual fund.
• Dividend warrants have to be dispatched to investors within 30 days of

declaration of the dividend
• Redemption/re-purchase cheques would need to be dispatched to

investors within 10 working days from the date of receipt of transaction
request. Interest at the rate of 15 percent p.a. to be paid for delay in
payment.
• The investor/s can appoint upto 3 nominees
• The investor can also pledge the units
• Unit-holders have the right to inspect key documents such as Trust Deed,
Investment Management Agreement, Custodial Services Agreement, RTA
agreement and Memorandum & Articles of Association of the AMC.
• AMC shall within 1 month from the close of each half year (i.e. 31st Mar
and 30th Sep), host a soft copy of its unaudited financial result on their
website.
! !247
• Scheme-wise Annual Report or an abridged summary has to be emailed

to all unit-holders within four months of the close of the financial year.
• Unit holder is provided various escalation levels within AMC for redressal
of grievances before approaching SEBI.
• AMC can recover investment management and advisory fees on

management of unclaimed amounts, at a maximum rate of 0.50 percent
per annum and there shall be no exit loads charged on this plan..
6.4 Mutual Fund schemes and objectives
Before an investor decided to invest in any Mutual Fund Scheme, he needs

to understand first what are his investment objectives, investment policies
and investment strategies based on his life goals and risk appetite based
on his life stage.
The investment objective should help the investor to accomplish a life goal.
For e.g. if life goal is to buy a car, then the investment objective is to make
the money grow equivalent to the cost of buying a car. Investment in
equity related securities can fetch capital appreciation, diversified debt
scheme can generate periodical returns and a balanced scheme can
provide both income and capital appreciation. The investment objective will
enable an investor to make plans for accomplishing his overall goals.
A mutual fund may invest moneys collected under any of its schemes only
in:
a. securities;
b. money market instruments;
c. privately placed debentures;
d. securitised debt instruments, which are either asset backed or
mortgage backed securities
e. gold or gold related instruments
f. real estate assets
g. infrastructure debt instrument and assets
In the same vein, Investment Policy will help the investor to determine
what type of securities he should buy because various securities give
different returns. Here he may have to decide how much percentage of
money needs to be allocated to a particular security. The investor needs to
! !248
decide the percentage of investment in equity or debt, the percentage of

investment in risky and not risky stock, the percentage of investment in
large cap, mid cap and small cap.
Investment Strategy is to be crafted to decide upon the approach for

accomplishing investment objectives. This approach will decide the time
frame for investment, choice between risky and non risky securities, the
buying price and the expected target price etc.
An investor can purchase units in a mutual fund scheme either through a

NFO or subsequently in an open ended scheme. A mutual fund scheme is
offered to public investors for the first time through an New Fund Offer
(NFO).
Investors can know the scheme details through Offer Document. SEBI has
instructed Mutual Fund to provide all necessary information about the
scheme in the Offer Document.
As per SEBI regulations the mutual fund Offer Document comprises of two
parts:
a. Scheme Information Document (SID), which has details of the particular

scheme
b. Statement of Additional Information (SAI), which has statutory

information the AMC, that is offering the scheme.
The SID and SAI should be prepared in the SEBI format and needs to be
sent to SEBI for observations. Thus the offer document is not approved but
vetted by SEBI. The observations made by SEBI needs to be incorporated
in the revised Offer Document. The revised SID has to be hosted on AMFI’s
website (www.amfiindia.com) two days before the issue opens. SID is to be
updated every year unless there are important changes in attributes or the
scheme is launched during a particular period.
! !249
The SID should have the following details of the scheme:
• Name of the scheme.
• Type of the scheme Open/Closed/Interval/Equity/Balanced/Income/Debt/

Liquid/ETF etc.
• Offer of Units for New Fund Offer and Continuous offer for Units at NAV
based prices.
• NFO open close and reopening date dates of the scheme.
• Name of the mutual fund, and name and contact information of the AMC
and trustee company.
• Declaration that the particulars of the Scheme have been prepared in

accordance with the Securities and Exchange Board of India (Mutual
Funds) Regulations 1996 and filed with SEBI, along with a Due Diligence
Certificate from the AMC.
• Instructions to investors to ascertain about any further changes to this

Scheme before investing.
• The investors are advised to refer to the Statement of Additional

Information (SAI) for other details.
• Table of Contents
• Highlights/Summary of the scheme
• Investment objective
• Liquidity
• Benchmark
• NAV Disclosure
• Load structure
! !250
• Minimum Application Amount
• Requirements for minimum investors
• Risk Factors: Standard and Scheme Specific
• Provisions regarding minimum number of investors in the scheme
• Special considerations
• Definitions
• Due Diligence Certificate (issued by the AMC)
• Information about the scheme: Type, Investment Objective, Asset

Allocation, Where will the scheme invest, Investment strategy,
Fundamental attributes, Who will manage the scheme, How will the
scheme benchmark its performance, Investment restrictions, How has
the scheme performed
• Proposed asset allocation mix and nature of investments in which the

money of the scheme will be deployed
• Fees & Expenses
• Rights of Unit-holders
• Penalties, Litigation etc
The SID should also put a label on the mutual fund scheme based on the
schemes ability to create wealth or generate income, investment objective
and risk involved. AMCs also give a pictorial representation of the risk to
the principal invested in a mutual fund product through a ‘Riskometer’. The
Riskometer classifies the risk in the scheme into five levels of risk as
follows: 
! !251
Level of Risk Type of Scheme
Low Liquid Fund
Moderately Low Capital Protection Oriented

Scheme
Moderate Monthly Income Plans
Moderately High Exchange Traded Fund
High Sector Fund
SEBI had replaced the mandatory colour codes (wherein the funds needed
to be given blue, yellow and brown codes to indicate low, medium and high
risk respectively with a riskometer to help investors better understand risks
involved in mutual fund investments.
The recently launched CPSE ETF in November 2018 displayed the following
riskometer:
!
Investor understand that their Principle will be at high risk
Source: https://investeasy.reliancemutual.com
Investors should refer the updated riskometer before investing and

understand more details after reading all scheme related documents
! !252
carefully rather than taking investment decidions only on one or two

parameters.
The product labels are to be disclosed in Front page of initial offering

application forms, Key Information Memorandum (KIM) and Scheme
Information Documents (SIDs).
The SAI should have the following details of the scheme:
• Information and details about Sponsors, AMC, Trustee Company,

Custodian, Registrar & Transfer Agent, Statutory Auditor, Fund
Accountant (if outsourced) and Collecting Bankers
• Condensed financial information (for schemes launched in last 3 financial

years)
• The process of applying for mutual fund units
• Rights of Unit-holders
• Investment Valuation Norms
• Tax provisions
• Legal provisions
• Investor grievance redressal mechanism
• General Information
SAI is available on the mutual funds website as well as AMFI website.

Investors should also carefully read the SAI before investing in order to get
a better understanding of the disclosures. SAI needs to be updated by the
end of 3 months of every financial year
! !253
Key Information Memorandum (KIM)
KIM has to be accompanied with the application form. KIM is a summary of

the SID and SAI and contains essential information from the offer
document to help the investor to know specific details about the scheme
and to make a informed decision based on the suitability of the investment
for their needs. KIM is to be updated at least once a year.
The KIM should have the following details of the scheme:
• Name of the AMC, mutual fund, Trustee, Fund Manager and scheme
• Dates of Issue Opening, Issue Closing & Re-opening for Sale and Re-
purchase
• Investment Objective
• Plans and Options under the scheme
• Asset Allocation Pattern
• Risk Profile of Scheme
• Price at which Units are being issued and minimum amount/units for
initial purchase, additional purchase and re-purchase
• Daily Net Asset Value (NAV) Publication
• Benchmark Index
• Performance of scheme and benchmark over last 1 year, 3 years, 5 years

and since inception
• Dividend Policy
• Loads and expenses
• Tax treatment for the Investors
! !254
• Investor Grievances contact and contact information of Registrar for

taking up investor grievances
• Unitholders’ Information
Types of Mutual Fund Schemes
In order to understand the offer document an investor should first know

the different types of Mutual Fund Schemes and the various plans and
options to invest suiting his needs.
No scheme shall be launched by the asset management company unless

such scheme is approved by the trustees and a copy of the offer document
has been filed with SEBI.
The sponsor or asset management company shall invest not less than one
percent of the amount which would be raised in the new fund offer or fifty
lakh rupees, whichever is less, in the growth option of the scheme and
such investment shall not be redeemed unless the scheme is wound up.
The offer document shall contain disclosures which are adequate in order
to enable the investors to make informed investment decision.
No one shall issue any form of application for units of a mutual fund unless
the form is accompanied by the memorandum containing such information
as may be specified by SEBI.
The asset management company shall provide an option to the unitholder

to nominate.
There are multiple mutual fund schemes offered by over 40 mutual funds.
The investor had to choose from many schemes. There was a need to bring
in uniformity in the characteristics of similar type of schemes launched by
different Mutual Funds in order to ensure that an investor of Mutual Funds
is able to evaluate the different options available, before taking an
informed decision to invest in a scheme. Hence the Securities and
Exchange Board of India (SEBI) has issued a circular to Mutual Funds/Asset
Management Companies (AMCs)/Trustee Companies/Boards of Trustees of
Mutual Funds/AMFI for Categorization and Rationalization of Mutual Fund
Schemes.
! !255
Main highlights if the above said SEBI circular number SEBI/HO/IMD/DF3/

CIR/P/2017/114 dated October 6, 2017 is as follows:
Definition of Large Cap, Mid Cap and Small Cap
a. Large Cap: 1st-100th company in terms of full market capitalization
b. Mid Cap: 101st-250th company in terms of full market capitalization
c. Small Cap: 251st company onwards in terms of full market

capitalization
The Schemes would be broadly classified in the following groups:
(a) Equity Schemes

(b) Debt Schemes
(c) Hybrid Schemes
(d) Solution Oriented Schemes
(e) Other Schemes
! !256
A. Equity Schemes:
Sr. Category of Scheme Type of scheme (uniform

No. Schemes Characteristics description of scheme)
1 Multi Cap Fund Minimum investment in Multi Cap Fund- An open
equity & equity related ended equity scheme investing
instruments-65% of across large cap, mid cap,
total assets small cap stocks
2 Large Cap Fund Minimum investment in Large Cap Fund- An open

equity & equity related ended equity scheme
instruments of large cap predominantly investing in
companies- 80% of total large cap stocks
assets
3 Large & Mid Cap Minimum investment in Large & Mid Cap Fund- An
Fund equity & equity related open ended equity scheme
instruments of large cap investing in both large cap and
companies- 35% of total mid cap stocks
assets Minimum
investment in equity &
equity related
instruments of mid cap
stocks- 35% of total
assets
4 Mid Cap Fund Minimum investment in Mid Cap Fund- An open ended
equity & equity related equity scheme predominantly
instruments of mid cap investing in mid cap stocks
companies- 65% of total
assets
5 Small cap Fund Minimum investment in Small Cap Fund- An open
equity & equity related ended equity scheme
instruments of small cap predominantly investing in
companies- 65% of total small cap stocks
assets
6 Dividend Yield Scheme should An open ended equity scheme

Fund predominantly invest in predominantly investing in
dividend yielding stocks. dividend yielding stocks
Minimum investment in
equity- 65% of total
assets
! !257
7 Value Fund Scheme should follow a An open ended equity scheme

value investment following a value investment
strategy. Minimum strategy
equity related
instruments - 65% of
total assets
8 Contra Fund Scheme should follow a An open ended equity scheme
contrarian investment following contrarian
strategy. Minimum investment strategy
equity related
total assets
9 Focused Fund A scheme focused on An open ended equity scheme

the number of stocks investing in maximum 30
(maximum 30) stocks (mention where the
Minimum investment in scheme intends to focus, viz.
equity & equity related
total assets
10 Sectoral/ Minimum investment in An open ended equity scheme
Thematic equity & equity related investing in __ sector
instruments of a (mention the sector)/ An open
particular sector/ ended equity scheme following
particular theme 80% of __ theme (mention the theme)
total assets
11 ELSS Minimum investment in An open ended equity linked

equity & equity related saving scheme with a
instruments -80% of statutory lock in of 3 years
total assets (in and tax benefit
accordance with
Equity Linked Saving
Scheme, 2005 notified
by Ministry of Finance)
! !258
B. Debt Schemes
Sr. Category of Scheme Type of scheme (uniform

No. Schemes Characteristics description of scheme)
1 Overnight Fund Investment in overnight An open ended debt scheme
securities having investing in overnight
maturity of 1 day securities
2 Liquid Fund Investment in Debt and An open ended liquid scheme

money market securities
with maturity of upto 91
days only
3 Ultra Short Investment in Debt & An open ended ultra-short
Duration Fund Money Market term debt scheme investing in
instruments such that instruments with Macaulay
the Macaulay duration of duration between 3 months
the portfolio is between and 6 months
3 months - 6 months
4 Low Duration Investment in Debt & An open ended low duration

Fund Money Market debt scheme investing in
the Macaulay duration of duration between 6 months
the portfolio is between and 12 months
6 months- 12 months
5 Money Market Investment in Money An open ended debt scheme
Fund Market investing in money market
instruments having instruments
maturity upto 1year
6 Short Duration Investment in Debt & An open ended short term

Fund Money Market debt scheme investing in
the Macaulay duration of duration between 1 year and 3
the portfolio is between years
1 year – 3 years
! !259
7 Medium Investment in Debt & An open ended medium term

Duration Money Market debt scheme investing in
Fund instruments such that instruments with Macaulay
the Macaulay duration of duration between 3 years and
the portfolio is between 4 years
3 years – 4 years
8 Medium to Long Investment in Debt & An open ended medium term
Duration Fund Money Market debt scheme investing in
the Macaulay duration of duration between 4 years and
the portfolio is between 7 years
4 – 7 years
9 Long Duration Investment in Debt & An open ended debt scheme

Fund Money Market investing in instruments with
Instruments such that Macaulay duration greater
the Macaulay duration of than 7 years
the portfolio is greater
than 7 years
10 Dynamic Bond Investment across An open ended dynamic debt
duration scheme investing across
duration
11 Corporate Bond Minimum investment in An open ended debt scheme

Fund corporate bonds- 80% of predominantly investing in
total assets (only in highest rated corporate bonds
highest rated
instruments)
12 Credit Risk Minimum investment in An open ended debt scheme
Fund corporate bonds- 65% of investing in below highest
total assets (investment rated corporate bonds
in below highest rated
instruments)
13 Banking and Minimum investment in An open ended debt scheme

PSU Fund Debt predominantly investing in
instruments of banks, Debt instruments of banks,
Public Sector Public Sector Undertakings,
Undertakings, Public Public Financial Institutions
Financial Institutions-
80% of total assets
! !260
14 Gilt Fund Minimum investment in An open ended debt scheme

Gsecs- 80% of total investing in government
assets (across maturity) securities across maturity
15 Gilt Fund with Minimum investment in An open ended debt scheme
10 year Gsecs- 80% of total investing in government
constant assets such that the securities having a constant
duration Macaulay duration of the maturity of 10 years
portfolio is qual to 10
years
16 Floater Fund Minimum investment in An open ended debt scheme

floating rate predominantly investing in
instruments- 65% of floating rate instruments
total assets
C. Hybrid Schemes
Sr. Category of Type of scheme (uniform

Scheme Characteristics
No. Schemes description of scheme)
1 Conservative Investment in equity & An open ended hybrid scheme
Hybrid Fund equity related instruments- investing predominantly in
between 10% and 25% of debt instruments
total assets; Investment in
Debt instruments between
75% and 90% of total
assets
2 Balanced Equity & Equity related An open ended balanced

Hybrid instruments between 40% scheme investing in equity and
Fund and 60% of total assets; debt instruments
Debt instruments-
between 40% and 60% of
total assets No Arbitrage
would be permitted in this
scheme
3 Aggressive Equity & Equity related An open ended hybrid scheme
Hybrid Fund instruments between 65% investing predominantly in
and 80% of total assets; equity and equity related
Debt instruments- instruments
between 20% &35% of
total assets
! !261
4 Dynamic Investment in equity/ debt An open ended dynamic asset

Asset that is managed allocation fund
Allocation or dynamically
Balanced
Advantage
5 Multi Asset Invests in at least three An open ended scheme
Allocation asset classes with a investing in __, __, __
minimum allocation of at (mention the three different
least 10% each in all three asset classes)
asset classes
6 Arbitrage Scheme following arbitrage An open ended scheme

Fund strategy. Minimum investing in arbitrage
investment in equity & opportunities
equity related instruments
65% of total assets
7 Equity Minimum investment in An open ended scheme
Savings equity & equity related investing in equity, arbitrage
instruments- 65% of total and debt
assets and minimum
investment in debt- 10%
of total assets Minimum
hedged & unhedged to be
stated in the SID Asset
Allocation under defensive
considerations may also be
stated in the Offer
Document
! !262
D. Solution Oriented Schemes
Sr. Category of Type of scheme (uniform

Scheme Characteristics
1 Retirement Scheme having a lock-in An open ended retirement
Fund for at least 5 years or till solution oriented scheme having
retirement age whichever a lock-in of 5 years or till
is earlier retirement age (whichever is
earlier)
2 Children’s Scheme having a lock-in An open ended fund for
Fund for at least 5 years or till investment for children having a
the child attains age of lock-in for at least 5 years or till
majority whichever is the child attains age of majority
earlier (whichever is earlier)
A. Other Schemes
Sr. Category of Scheme Characteristics Type of scheme (uniform

1 Index Funds/ Minimum investment in An open ended scheme
ETFs securities ofa particular index replicating/ tracking _ index
(which is being replicated/
tracked)- 95% of total assets
2 FoFs Minimum investment in the An open ended fund of fund
(Overseas/ underlying fund- 95% of scheme investing in ___
Domestic) total assets fund (mention the
underlying fund)
Open-ended funds are open for investors to enter or exit at any time,
even after the NFO.
Close-ended funds have a fixed maturity and can be bought only during
its NFO. Post NFO units can be traded on stock exchange.
Interval funds combine features of both open-ended and close-ended

schemes. They are largely close-ended, but become open-ended at pre-
specified intervals.
! !263
Actively managed funds gives flexibility to the investor to buy and sell
securities to build a profitable portfolio.
Passive funds invest on the basis of a specified index and shares are
bought on the basis of the composition of the index.
Exchange Traded Funds (ETFs) build portfolio on the basis of an index

or benchmark such as an equity market index or a commodity index but
are traded at real time prices that are linked to the changes in the
underlying index. ETFs are investment funds traded on stock exchange. An
equity ETF consists of stocks of different companies. Growth ETFs consist
of equity from large, blue chip companies that are expect to perform better
with minimal volatility.
Exchange traded funds (ETFs) are a hybrid of open-ended mutual funds

and listed individual stocks. They are index funds listed on stock exchanges
and trade like individual stocks on the stock exchange. Since they are like
passive funds they charge lesser fees. ETFs can be created out of indices,
and gold.
Gold Exchange Traded Fund, (ETF) is like an index fund that invests in
gold. The NAV of such funds moves in line with gold prices in the market.
Gold price would be the benchmark for such funds.
CPSE ETF is an equity instrument that tracks an index and can be traded
on a Stock Exchange. This CPSE ETF is made up of equity investments in
11 of India’s largest public sector companies. The CPSE ETFs are open-
ended Index Exchange Traded scheme with no lock-in. Upfront Discount
and NIL Entry & Exit Load becomes an attraction in a Further Fund
Offer(FFO).
Gold Sector Funds invests unit holders money in shares of companies

engaged in gold mining and processing.
Equity funds invest in equity instruments issued by companies for long-

term appreciation in the value of the portfolio and dividends.
Diversified equity fund invest in a diverse mix of securities of different

sectors and market capitalization.
! !264
Market Segment based funds invest in companies of a particular market

size e.g. large cap, mid cap small cap.
Sector funds invest in only a specific sector e.g. Banking sector, IT sector,
Pharmaceutical sector, Automobile sector, Oil company sector etc.
Thematic funds invest in line with an investment theme e.g.

infrastructure, toll-collection, cement, steel, telecom, power etc
Strategy-based Schemes have portfolios that are created and managed

based on certain strategy.
Equity Income/Dividend Yield Schemes invest in securities whose

shares fluctuate less, and the dividend represents a larger proportion of
the returns.
Value fund invests in shares of fundamentally strong companies that are

currently under-valued in the market and have hopes to rise substantially
in the future.
Growth funds portfolios feature companies whose earnings are expected to

grow at a rate higher than the average rate.
Focused funds hold portfolios concentrated in a limited number of stocks.
International funds offer investors to invest outside the country. The

investment could be specific to a country or diversified across countries.
Equity Linked Savings Schemes (ELSS) are diversified equity funds

that offer tax benefits to investors under section 80 C of the Income Tax
Act up to an investment limit of Rs. 150,000 a year.
Real Estate Mutual Fund scheme invests directly or indirectly in real

estate assets and at least 35 percent of the portfolio should be held in
physical assets. Not less than 75 percent of the net assets of the scheme
shall be in real estate assets, mortgage-backed securities, equity shares or
debentures of companies engaged in dealing in real estate assets or in
undertaking real estate development projects.
! !265
Real Estate Investment Trusts (REIT) are trusts registered with SEBI
that invest in commercial real estate assets. The REIT will raise funds
through an initial offer and subsequently through follow-on offers, rights
issue and institutional placements. The value of the assets owned or
proposed to be owned by a REIT coming out with an initial offer will not be
less than Rs. 500 crore and the minimum offer size will not be less than Rs.
250 crore. The minimum subscription amount in an initial offer shall be Rs.
2 lakh.
Infrastructure Investment Trusts (InvIT) are trusts registered with

SEBI that invest in the infrastructure sector. The InvIT will raise funds from
the public through an initial offer of units. The offer shall be for not less
than Rs. 250 crores and the value of the proposed assets of the InvIT shall
not be less than Rs. 500 crores. The minimum subscription size will be Rs.
10 lakh.
6.5 Mutual Fund Distribution channels
Mutual Fund Distribution channels can be classified into
(a) Individuals
(b) Institutional
Individual distributors, comprises of Individual Financial Advisors (IFA) who

provide resources for new mutual fund unitholders acquisitions.
Due to financial sector reforms Institutional Distribution channels have also

established deeper roots in the Indian financial sector. Brokerage firms,
Banks and Non-banking finance companies (NBFC) represent the
Institutional Distribution channels.
Newer distribution channels have emerged with the advent of technology.

Investors can buy mutual fund units directly through the website of the
mutual fund and also save on transaction costs that otherwise was to be
paid to the distributors. Investors can buy mutual fund units from other
electronic platforms provided by stock exchanges such as NSE’s MFSS and
BSE’s StAR platform.
! !266
Mutual funds offer the Direct Plan and the Regular Plan for investors. Under
the Direct Plan investors will have a lower expense ratio as there are no
distribution expenses or commissions paid to distributor. Under the Regular
plan the investor indicates a distributor ARN in the application form and the
mutual fund pays the transaction charges and commissions to the
distributor.
A new cadre of distributors, such as postal agents, retired government and

semi-government officials (class III and above or equivalent), retired
teachers and retired bank officers with a service of at least 10 years have
emerged to sell units of simple and performing mutual fund schemes.
Simple and performing mutual fund schemes comprises diversified equity
schemes, fixed maturity plans (FMPs), Liquid and Money Market schemes,
Retirement benefit schemes having tax benefits and index schemes that
have returns equal to or better than their scheme benchmark returns
during each of the last three years.
Distributors were paid initial or upfront commission on the amount

mobilized by the distributor. However SEBI has recently done away with
the payment of upfront commission recently. AMCs will have to henceforth
commission through a full tail model in all schemes. Trail commission is
calculated as a percentage of the net assets of Units sold by the distributor.
Distributors benefit from as it is calculated on net assets which means
distributors benefit from increase in net assets arising out of valuation.
Additional commission is paid to the distributors from B30 (beyond top 30
cities) for investments only from individual investors in a trail mode.
A transaction charge is paid to distributors for investments of Rs. 10,000
and over. For subscriptions from existing investors the distributor is paid
Rs. 100 per transaction and for new investors across mutual funds the
distributors are paid Rs. 150 to encourage widening the investor base of
mutual funds.
The distributors have to disclose all the commissions and transaction

charges payable to them for the different competing schemes of various
mutual funds.
MF Utilities (MFU) is a transaction aggregating platform that connects

investors, RTAs, distributors, banks, AMCs and others. MFU facilitates the
distributors with online access to submit investor transactions. Investors
! !267
who register on the MFU are allotted a Common Account Number (CAN).
All the investor holdings are consolidated under CAN.
6.6 Net Asset Value (NAV)
Mutual funds are required to declare their NAVs and sale-repurchase prices
of all schemes updated daily on a regular basis on the AMFI website by
8.00 p.m. and declare NAVs of their close-ended schemes on every
Wednesday.
The net asset value of a fund is the market value of the assets minus the
liabilities on the day of valuation. A mutual fund compute the Net Asset
Value of each scheme by dividing the net assets of the scheme by the
number of units outstanding on the valuation date.
NAV is calculated at mark to market which means each security in the

investment portfolio is valued at its current market price. Hence investors
can buy or sell units on the basis of the information contained in the NAV.
SEBI has discontinued the process of charging entry load by AMCs on

buying new units by investors. Mutual Funds are permitted to charge exit
load i.e. keep the Re-purchase Price lower than the NAV. Investors are
incentivized to hold their units longer, by reducing the load as the unit
holding period increased. Investment and Advisory Fees are charged to the
scheme by the AMC. Initial Issue expenses are incurred at the time of
launching a scheme in an NFO. Recurring Expenses such as brokerage,
marketing and selling, statutory investor communication, insurance
premium, listing fees and depository fees etc are incurred to manage the
funds of the investors.
The total expense of the scheme should be with the prescribed limits of
SEBI. SEBI has instructed AMCs to reduce the expense ratio across
schemes to make investing in mutual funds cheaper and affordable. Costs
of both direct and indirect plans are falling.
! !268
The appreciation in daily NAV can happen due to the following profitability
parameters given in the following formula:
(A) Interest income

(B) + Dividend income
(C) + Realized capital gains
(D) + Valuation gains
(E) – Realized capital losses
(F) – Valuation losses
(G) – Scheme expenses
For e.g. NAV can be calculated as follows with the following

information
Value of stocks: Rs. 100 crore
Value of bonds: Rs. 50 crore
Value of money market instruments: Rs. 3.00 crore
Dividend accrued but not received: Rs. 1.00 crore
Interest accrued but not received: Rs. 0.20 crore
No. of outstanding units: 2.10 crore
NAV = (Value of stocks + Value of bonds + Value of money market

instruments + Dividend accrued but not received + Interest accrued but
not received)/ No. of outstanding units
NAV = (100 + 50 + 3 + 1 +2.20)/2.10 = 156.20/2.10 = Rs. 74.38
! !269
Fresh purchase or initial purchase of mutual fund units in a scheme can be

made during the new fund offer (NFO) period. Post NFO in an open-ended
scheme, during the open offer period fresh purchases can be made on the
current NAV. Investors have to make their choice of scheme, plan, option
and payout option at the time of making the application Once an investor
has a folio with a mutual fund, subsequent investments with the same
mutual fund with a transaction slip.
Payments for mutual fund purchases has to be made through the banking
channel modes by Cheque/Demand Draft or even electronically through
Internet banking,mobile banking, RTGS/NEFT/ECS/NECS Unified Payment
Interface, Aadhaar Enabled Payment Service, National Unified USSD
Platform, Cards, E-Wallets (restricted to Rs. 50,000/ per investor per
financial year) Application Supported by Blocked Amount (ASBA), Cash
Payments upto Rs. 50,000 per investor, per mutual fund, per financial year.
The investor will allotted units based on the amount invested and
applicable NAV i.e. investment amount divided by the NAV would give the
number of units allotted to the investor.
If the investor is in need of money (in an open ended scheme) he can offer
the units for repurchase to the mutual fund by submitting a dully filled
transaction slip. The re-purchase price will be the applicable NAV on ‘Cut-
off Time’ less Exit Load if any. The redemption proceeds will be paid in
favour of the sole/first holder of the folio. SEBI has prescribed cut-off
timing to determine the applicable NAV.
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Type of Scheme Transaction Cut off Applicable NAV

time
Equity oriented Purchases and 3.00 Same day NAV if received
funds and debt Switch ins pm before cut off time.
funds (except Next business day NAV for
liquid funds) in applications received after
respect of cut off time
purchases less
than Rs. 2 lakhs
Equity oriented Purchases and 3.00 Irrespective of the time of

funds and debt Switch ins pm receipt of application, NAV of
funds (except the business day on which
liquid funds) in the funds are available for
respect of utilisation
transaction equal
to or more than
Rs. 2 lakhs
Liquid fund Purchases and 2.00 If application received upto
Switch ins pm the cut off time and funds are
available for utilisation before
the cut-off time then closing
NAV of the previous day is
applicable. If application
received after cut off time
and funds available for
utilisation on the same day
then closing NAV of the same
day is applicable.
Equity Oriented Redemptions and 3.00pm Same day NAV if received

Funds, Debt funds Switch outs before cut off time.
(Other than Liquid Next business day NAV for
funds) applications received after
cut off time
Liquid funds Redemptions and 3.00pm NAV of day immediately
Switch outs preceding the next business
day, if received before cut off
time.
Next business day NAV for
applications received after
cut off time.
! !271
6.7 Investment Plans
Equity-oriented mutual funds more risky compared to debt mutual funds as

their returns are market linked. The proportion of risk varies from scheme
to scheme. Sectoral schemes are considered to be most risky. Liquid
schemes are considered to have least risk.
The selection of a mutual fund scheme depends upon the financial goal of
the investor. Based on investors need, risk appetite and time horizon, the
asset class for investment is determined. An investor looking for growth
will prefer equity, while a debt scheme will be chosen for fulfilling income
needs. Regular income can be obtained from hybrid schemes such as
monthly income plan.
An investor has to evaluate the different approaches, styles and value

systems in doing business of AMCs before investing in any of its schemes.
An investor should also evaluate the fund performance and ensure that the
fund performance outperformed the benchmark consistently. The fund’s
portfolio also has to be evaluated to determine the risk and return in the
scheme. The size of funds, the age of the fund portfolio turnover and
scheme running expenses should also be suitably evaluated.
An investment plan should be able to convert the needs of the investor into
financial goals. The basic objective of investment planning is to ensure that
the right amount of money is available at the right time to meet the
various financial goals of the investor. Investor can make various plans to
tailor investments and calibrate a structured payouts to accomplish
financial goals.
Systematic Investment Plan (SIP)
In a Systematic Investment Plan (SIP) investor invests constant amounts

at regular intervals. The main advantage of investing through SIP is
investor need know the entry point or exit point as the constant amount at
regular intervals averages the cost of buying. This average cost will be
definitely lower than the highest cost during the tenure of investment. This
approach is especially useful in a volatile market. This approach also
enables the investor to contribute a smaller amount till hi financial goal is
achieved. It is like your recurring deposit where you put in a small amount
every month. SIP has brought mutual funds within the reach of an average
! !272
person as it enables even those with tight budgets to invest Rs. 500 or Rs.
1,000 on a regular basis in place of making a heavy, one-time investment.
Investors can start with a small amount and can increase the amount of
SIP as and when his income increases. SIP approach makes the investor
disciplined, motivated the savings habit and if the SIP is started at a
younger age it gives the advantage of compounding over a longer period.
An SIP can be cancelled by giving due notice of the same to the AMC.
Systematic Withdrawal Plan (SWP)
Systematic Withdrawal Plan (SWP) is exactly opposite of Systematic

Investment Plan (SIP). In a Systematic Investment Plan (SIP) an investor
does not want tto invest the entire amount at the market peak. In a
Systematic Withdrawal Plan (SWP) an investor does not want to withdraw
the entire amount at the lowest market NAV. SWP provides investors with a
specific amount of payout at a pre-determined time intervals, like monthly,
quarterly, half-yearly or annually. The investor repurchases his units at an
average NAV during a certain period. An investor can book profits by
specifying that the units would be re-purchased if the market reaches a
particular level. Here again the investor does not repurchase the entire
invested amount at a market low but gets a better average NAV that is
higher that the market low and thus gets more redemption value. The
withdrawal is not fixed but will vary depending upon the availability of
appreciation in the specific investment chosen by the investor. This
approach preserves the capital and appropriate number of units will be
redeemed to book the gains. The SWP approach minimizes the risk of
redeeming all the units during a market low and meets need based liquidity
requirements. SWP is also better in terms of generating returns to keep up
with inflation especially is one opts for the equity fund route. An SWP will
stand cancelled when all the units are redeemed.
Systematic Transfer Plan (STP)
In a Systematic Transfer Plan (STP) the amount that is withdrawn from a

scheme is re-invested in some other better scheme. Hence STP is a
combination of SWP and SIP. STP is useful when the investor has s
lumpsum amount to invest. Instead of investing the entire amount into
Equity Fund in one go, he can invest that amount in any Debt Fund of the
same Fund House and opt for a Systematic Transfer to the Equity Fund.
STP approach protects the investor from market volatility in the short term.
! !273
STP can also be used to insulate the savings when the investor is nearing
the financial goals by starting a STP from the Equity Fund to a Debt Fund.
Tax benefits upto Rs. 1.5 lacs are available under Section 80C for both SIP
and STP. Exit loads and taxes will apply like any other redemption
transactions. The STP is cost effective and convenient as investor does not
have to do two documentation for SIP and SWP. STP can also be effectively
used to rebalance the portfolio, investing in a volatile market and even to
book profits. A systematic transaction can be cancelled at any time by
giving due notice of the same to the AMC.
6.8 Investment Options
Mutual Funds offer flexible and transparent investment options for the
investor to invest as per his risk profile. Investment Options can be
classified into the following three types:
1. Growth option
2. Dividend payout option
3. Dividend re-investment option
Investment option may give a similar portfolio returns but they differ in the
structure of cash flows and income accruals for the unit-holder. The post-
tax return may also be different based on the number of units held and
value of those units.
Growth option
• Dividend is not declared

• Based on the returns the asset value appreciates
• NAV capture the full value of the portfolio gains
• No increase in the number of units
• NAV of these units will be higher
• Taxability would depend on the scheme type and period of holding
Dividend payout option
• Dividend is declared from time to time

• NAV of the units falls to that extent
• Mutual Fund needs to pay a dividend distribution tax (DDT)
• NAV of these units is reduced
! !274
Dividend re-investment Option
• NAV declines to the extent of dividend and dividend distribution tax

• Investor does not receive the dividend but the dividend payout is re-
invested in the same scheme and additional units are allotted to the
investor
• Reinvestment is done at ex-dividend NAV
How to measure the performance of a Mutual Fund?
Mutual fund performance can be viewed from different perspective. It can

be on the basis of absolute returns i.e. returns earned by the scheme or as
a relative issue, judged against the performance of an appropriate
benchmark. The relative size of mutual fund companies is assessed by their
assets under management (AUM). Assets under management is the
amount mobilized from investors to invest in a particular scheme. We can
also consider a fund's performance against its peer group as well as
against its benchmark index. Such comparison could be indicative of
outperformance by the fund manager
AMCs and trustees are expected to conduct periodic reviews of fund

performance, as per the SEBI Guidelines.
Investors would be more interested from an another approach to evaluate

the performance of mutual funds i.e. through the risk reward relationship
which means higher risk, ought to earn a better return. Such evaluations
are conducted through Risk-adjusted Returns.
Risk-adjusted returns can be measured by Sharpe ratio. Sharpe

Ratio uses Standard Deviation as a measure of risk.
Sharpe Ratio = (Risk taken to earn the return(Rt) – Risk free return(Rf))/
Standard Deviation
Rt-Rf is called the risk premium i.e the advantage gained by the investor
because of risk taken.
For e.g if risk free return is 3 percent, and a scheme with standard
deviation of 0.3 percent earned a return of 8 percent, its Sharpe Ratio
would be (8percent – 3 percent)/ 0.3 percent = 16.6
! !275
A higher Sharpe Ratio, indicates that the scheme has performed better.
Sharpe Ratio comparisons can be used for evaluation of performance for
the same asset class. For e.g. by using a Sharp Ratio an equity cannot be
compared with a debt.
Treynor Ratio can also be used for evaluating performance of mutual fund
schemes. Instead of Standard Deviation Treynor Ratio uses Beta as a
measure of risk.
Treynor Ratio = (Risk taken to earn the return(Rt) – Risk free return(Rf))/
Beta.
A higher Treynor Ratio, indicates that the scheme has performed better
Treynor Ratio comparisons are used for diversified equity schemes as Beta
is more relevant in diversified equity schemes.
Alpha measures the performance of the investment in comparison to a

suitable market index. Alpha is the difference between a scheme’s actual
return and its optimal return. Positive alpha means the scheme has
outperformed others.
AMCs are required to disclose on their websites schemes returns versus

benchmark returns in CAR terms for various periods namely 1 year, 3
years, 5 years, 10 years and since inception. For certain category of debt
funds performance of 7 days, 15 days, 1 month also needs to be displayed.
! !276
6.9 Taxation on Mutual Fund schemes
A mutual fund trust is exempt from tax on its income and earnings under
section 10(23D) of the Income Tax Act
AMC(s) can charge GST, as per applicable Taxation Laws, to the schemes
within the limits prescribed under SEBI (Mutual Fund) Regulations.
When an investor sells units of an equity fund in the stock exchange, or

offers them for re-purchase to the fund, he will have to incur Securities
Transaction Tax (STT). STT is not applicable on purchase of units of an
equity scheme. STT is not applicable on transactions in debt or debt-
oriented mutual fund.
The returns of the mutual fund are passed through its investors, and hence
the returns are taxed in the hands of the investors based on the type of
mutual fund scheme, the type of investor and the period of holding.
A tax of 10% (plus applicable surcharge and cess) is applicable for all
resident tax payers for dividend income of more than Rs. 10 lakh received
from domestic companies.
Investors in mutual fund schemes also have to pay tax on their capital
gains (i.e. difference between sale price and acquisition cost of the
investment).
Tax rate on Equity-oriented schemes
Individual/ Domestic
HUF Company
Long Term Capital Gains (units held for 10% 10%
more than 12 months)
Short Term Capital Gains (units held for 15% 15%

12 months or less)
As per the Finance Act 2018 Tax to be levied at the rate of 10% (without
indexation benefit) on long-term capital gains exceeding Rs. 1,00,000 in a
financial year provided transfer of such units is subject to Securities Transaction
Tax. All capital gains upto January 31, 2018 have been grandfathered.
! !277
Tax rate on Debt-oriented schemes
Individual/ HUF Domestic Company
Long Term Capital Gains 20% after indexation 20% after indexation
(units held for more than
36 months)
Short Term Capital Gains as per applicable income as per applicable income
(units held for 36 tax lab rate of the tax lab rate of the
months investor after adding the investor after adding the
or less) debt income debt income
Surcharge at 15% on Surcharge at 7% on base

base tax, is applicable tax is applicable where
where income of income of domestic
Individual/HUF unit corporate unit holders
holders exceeds Rs. 1 exceeds Rs. 1 crore but
crore and at 10% where does not exceed Rs. 10
income exceeds Rs. 50 crores and at 12% where
lakhs but does not exceed income exceeds Rs. 10
Rs. 1 crore. As per the crores. As per the
Finance Act 2018, "Health Finance Act 2018,
and Education Cess" will "Health and Education
be levied at the rate of Cess" will be levied at the
4% on aggregate of base rate of 4% on aggregate
tax and surcharge. of base tax and
surcharge.
For specific queries and latest updates investors should consult tax
consultant
! !278
6.10 Advantages of investing in Mutual Fund
Mutual Fund offer numerous advantages to the small and average

investors, to fulfill financial goals. Inspite of having no specific knowledge
of investing in finance markets, an average investor can literally outsource
the task of investing to experts fro Mutual Funds. The best part of this
outsourcing is that investment is diversified automatically with minimal
risk. One of the biggest advantage is the ability of the investor to invest as
well as redeem with ease and convenience. One can also switch their
investment from one asset class to another and successfully manage the
volatility of the market. The most important advantage is the investor
gains all these benefits in a highly regulated market to protect interest of
the investors by SEBI.
The top 10 advantages of investing in Mutual Funds can be listed as

follows:
1. Portfolio Diversification: Mutual funds, invest in a number of

companies across various sectors and industries. This diversification
minimises the risks of the investments. Investing in the units of a
scheme with a small amount provides investors the exposure to a range
of securities of a large portfolio at a minimal cost. investing through a
mutual fund gives various economic advantages to an investor as
compared to direct investing in terms of cost saving as an average
investor may not have a large corpus to invest in big securities nor able
to sustain the costs incurred for acquiring it.
2. Professional Management: An average investor does not knowledge

about capital market operations nor has the large financial resource to
obtain benefits of investment. Hence Fund Manager provide assistance
to the unitholders. The Fund Managers of Mutual Funds who invest
unitholders money in finance markets always invest in line with the
investment objective. This investing is based on adequate research, and
ensuring that prudent investment processes are followed. Fund
Managers have adequate experience, knowledge, and expertise to
analyse the performance of companies and make appropriate investing
decisions in the interest of the investors with organised investment
strategy which is not possible for an individual retail investor.
Professional Management simplifies the process of investing and holding
securities.
! !279
3. Liquidity: The mutual fund investors can easily convert their

investments into cash by way of selling their units to the fund in the
case of open-ended scheme or by selling units on a stock exchange in
the case of close-ended scheme. All this is done at the market value
without waste of time.
4. Various Plans and Options: The various plans and options offered by
Mutual Funds enables investors to structure their investments to fulfil
their financial goals. Investors can top up their investments as their
income increases or even withdraw a part of it for personal use or
reinvest in some other attractive scheme. Investors can also switch
holdings from one asset class to another with ease and simplicity.
5. Investor friendly procedures: The best part of investor friendly

procedure is to do one time documentation obtain your cKYC and then
for all subsequent investments one does not have to submit fresh KYC
documents again. Further purchases can be done with little
documentation. All further investments can be tracked with common
folio or PAN.
6. Strong check and control by Regulator: Investor does not have to

worry about any mal practices or fraud or over night vanishing of any
Mutual Fund as SEBI has a strong check and control on the entire
Mutual Fund industry.
7. Promote investment discipline: The systematic approach plans of

Mutual Funds promotes savings habit and discipline amongst investors,
irrespective of they possessing a lumpsum amount or able to contribute
a small portion of their income for savings. These approaches are help
full for investors to create, accumulate and protect long term wealth.
8. Tax benefits: In order to encourage citizens to pour in their savings for

the growth and development of the country, the Government has
provided various tax incentives to investors of mutual fund schemes
across various asset classes. Equity Linked Savings Schemes can reduce
the taxable income upto Rs. 1,50,000 in a financial year save tax on this
invested amount. Mutual funds are not liable to pay tax on the income
they earn where as the income earned by the investor could have
attracted tax liability.
! !280
9. Reduced Transaction Costs: The larger volumes undertaken by

Mutual Funds have negotiated transaction costs which is not possible for
the average investor due to small investment amount. In addition to the
brokerage the custodian fee for holding the electronic security is also
negotiated with various custodians.
10.Strong infrastructure support: As Mutual Fund investments can be

done or after investment support can be taken through individual
distributors as well as large institutions such as Banks an investor can
easily approach any of them. In case he could not find them in the close
proximity of residence / office he can always find an RTA or even do it
on his own through Mutual Funds Website or Stock Exchanges.
Limitations of Mutual Funds
1. Choice are many: Multiple options within standard schemes makes it

difficult for investors to select one from many
2. Dependency on Fund Managers: Unit holders does not get a chance

to select their own securities. They have to depend on the Fund
Managers
3. 100% of money contributed is not invested: Entire amount of

money contributed is not invested as part of it needs to spent on Mutual
Fund expenses
! !281
6.11 Summary
A Collective Investment Scheme(CIS) involves collecting money from

different investors inorder to invest this money in the financial markets to
earn income which is distributed to the investor after deduction of
expenses and tax. The capital appreciation is also shared by the investors.
CISs are regulated by the SEBI under SEBI (Collective Investment
Scheme) Regulations, 1999. The SEBI (Collective Investment Schemes)
(Amendment) Regulations, 2000 gave a new expression of ‘collective
investment scheme’ and said ‘collective investment scheme’ shall have the
same meaning as assigned to it under section 11AA of the Securities and
Exchange Board of India Act, 1992.
Before investing into any such collective investment schemes, investors

should ensure that such Collective Investment Management Company is
registered with SEBI.
The definition of CIS excludes mutual funds. However SEBI has defined
Mutual Funds in SEBI (Mutual Fund) Regulations, 1996 as “a fund
established in the form of a trust to raise monies through the sale of units
to the public or a section of the public under one or more schemes for
investing in securities including money market instruments or gold or gold-
related instruments or real estate assets. The primary role of mutual fund
is to assist investors in earning an income or building their wealth, by
participating in the schemes suiting investment objectives.
SEBI has stipulated a 3-tier legal structure which has inherent checks and
balances to protect the interests of the investors. A mutual fund is set up
in the form of a trust, which has sponsor, trustees, Asset Management
Company (AMC) and custodian.
Association of Mutual Funds in India (AMFI), is a mutual fund industry

body that has been created to promote the interests of the mutual funds
industry. Asset Management Companies (AMCs) in India are members of
AMFI.
Individuals as well as non individuals eligible for investment in Mutual

Funds
! !282
Before an investor decided to invest in any Mutual Fund Scheme, he needs

to understand first what are his investment objectives, investment policies
and investment strategies based on his life goals and risk appetite based
on his life stage.
The investment objective should help the investor to accomplish a life goal.
For e.g. if life goal is to buy a car, then the investment objective is to make
the money grow equivalent to the cost of buying a car. Investment in
equity related securities can fetch capital appreciation, diversified debt
scheme can generate periodical returns and a balanced scheme can
provide both income and capital appreciation. The investment objective will
enable an investor to make plans for accomplishing his overall goals.
Investment Strategy is to be crafted to decide upon the approach for

accomplishing investment objectives. This approach will decide the time
frame for investment, choice between risky and non risky securities, the
buying price and the expected target price etc.
An investor can purchase units in a mutual fund scheme either through a

NFO or subsequently in an open ended scheme. A mutual fund scheme is
offered to public investors for the first time through an New Fund Offer
(NFO).
Investors can know the scheme details through Offer Document. In order
to understand the offer document an investor should first know the
different types of Mutual Fund Schemes and the various plans and options
to invest suiting his needs.
There are multiple mutual fund schemes offered by over 40 mutual funds.
The investor had to choose from many schemes. Securities and Exchange
Board of India (SEBI) has issued a circular to Mutual Funds/Asset
Management Companies (AMCs)/Trustee Companies/Boards of Trustees of
Mutual Funds/AMFI for Categorization and Rationalization of Mutual Fund
Schemes.
! !283
Mutual Fund Distribution channels can be classified into
(a) Individuals
(b) Institutional
Mutual funds are required to declare their NAVs and sale-repurchase prices
of all schemes updated daily on a regular basis on the AMFI website by
8.00 p.m. and declare NAVs of their close-ended schemes on every
Wednesday.
An investor has to evaluate the different approaches, styles and value

systems in doing business of AMCs before investing in any of its schemes.
Investors can use different investment plans such as SIP, SWP and STP.
Mutual Funds offer flexible and transparent investment options for the
investor to invest as per his risk profile. Investment Options can be
classified into the following three types:
1. Growth option
2. Dividend payout option
3. Dividend re-investment option
A mutual fund trust is exempt from tax on its income and earnings under
section 10(23D) of the Income Tax Act
AMC(s) can charge GST, as per applicable Taxation Laws, to the schemes
within the limits prescribed under SEBI (Mutual Fund) Regulations.
When an investor sells units of an equity fund in the stock exchange, or

offers them for re-purchase to the fund, he will have to incur Securities
Transaction Tax (STT) . STT is not applicable on purchase of units of an
equity scheme. STT is not applicable on transactions in debt or debt-
oriented mutual fund.
The returns of the mutual fund are passed through its investors, and hence
the returns are taxed in the hands of the investors based on the type of
mutual fund scheme, the type of investor and the period of holding.
A tax of 10% (plus applicable surcharge and cess) is applicable for all
resident tax payers for dividend income of more than Rs.10 lakh received
from domestic companies.
! !284
Investors in mutual fund schemes also have to pay tax on their capital
gains ( i.e. difference between sale price and acquisition cost of the
investment).
Mutual Fund offer numerous advantages to the small and average

investors, to fulfill financial goals. Inspite of having no specific knowledge
of investing in finance markets, an average investor can literally outsource
the task of investing to experts fro Mutual Funds. The best part of this
outsourcing is that investment is diversified automatically with minimal
risk. One of the biggest advantage is the ability of the investor to invest as
well as redeem with ease and convenience. One can also switch their
investment from one asset class to another and successfully manage the
volatility of the market. The most important advantage is the investor
gains all these benefits in a highly regulated market to protect interest of
the investors by SEBI.
1. What is a Collective Investment Schemes and who regulates it?
2. What is a Mutual fund? What is the primary role of a mutual fund?
3. What is the Structure of Mutual Fund?
4. Why is Asset Management Company (AMC) called the operational arm of

a Mutual fund?
5. Who is the custodian of a Mutual fund and who appoint it?
6. What are the various officials connected with functioning of a Mutual

fund?
7. Who is a Registrar & Transfer Agent (RTA) and who appoints it?
8. Who is a KYC Registration Agencies and what are its functions?
9. Which type of Investors can invest in Mutual Funds?
10.Which type of Investors cannot invest in Mutual Funds?
! !285
11.A mutual fund may invest moneys collected under any of its schemes
in which securities?
12.As per SEBI regulations the mutual fund Offer Document comprises of
how many parts? Explain them.
13.What is a Key Information Memorandum (KIM)? The KIM should have

which details of the scheme?
14.What are the different types of Mutual Fund Schemes?
15.What are the different types of Mutual Fund Distribution channels?
16.What is a NAV and how is it calculated?
17.What are the different Investment Plans available for investors in

Mutual funds?
18.What are the different Investment Options available for investors in

Mutual funds?
19.How to measure the performance of a Mutual Fund?
20.Explain the provisions of Taxation on Mutual Fund schemes.
21.What are the advantages of investing in Mutual Fund?
! !286
1. An open ended mid cap equity scheme predominantly invests in mid cap
stocks. The minimum investment in equity and equity related
instruments of mid cap companies shall be how much percent of total
assets.
(a) 25
(b) 45
(c) 65
(d) 80
2. Investors invest in various schemes of the mutual fund. The record of

investors and their unit-holding may be maintained by the which of the
following tiers of the Mutual Fund?
(a) Sponsor
(b) Distributor
(c) Trustee
(d) AMC
3. Mutual Fund Offer Documents have three parts: (a) Scheme Information
Document (SID), which has details of the particular scheme (b)
Statement of Additional Information (SAI), (c) KIM document that is
accompanied by an application form. State whether the above
statement is true or false.
(a) True
(b) False
4. Which of the following is meant to reflect the true worth of each unit of
the scheme, because investors buy or sell units on the basis of the
information contained in it?
(a) NAV
(b) Alpha
(c) Beta
(d) Standard Deviation
! !287
5. Mutual Fund offer numerous advantages to the small and average

investors, to fulfill financial goals. One of the biggest advantage is the
ability of the investor to invest as well as redeem with ease and
convenience. Which of the following is not a benefit of investing in
Mutual Funds?
(a) Portfolio Diversification
(b) Choice overload
(c) Strong check and control by Regulator
(d) Liquidity
Ans: 1 - (c), 2 - (d), 3 - (b), 4 - (a), 5 - (b)
! !288
6.12 References
1. Indian Mutual Funds Handbook: A Guide for Industry Professionals and

Intelligent Investors by Sundar Sankaran
2. Indian Mutual funds for Beginners: A Basic Guide for Beginners to Learn
About Mutual Funds in India by Vipin Kats
3. In the Wonderland of Investment (FY 2018-19) by A. N Shanbhag and

Sandeep Shanbhag
4. Mutual Funds: An Introduction to the Core Concepts by Mark Mobius
5. The Complete Guide to Investing in Exchange Traded Funds: How to

Earn High Rates of Returns- Safely by Martha Maeda
6. Exchange Traded Funds for Beginners: An Essential Guide to Investing

in ETFs by Aaron Zepeda
7. http://www.moneycontrol.com/mutual-funds/top-rated-funds
8. https://economictimes.indiatimes.com/mf/best-mutual-funds-to-buy/
top-mutual-fund-schemes-to-invest
9. https://www.rediff.com/business/report/top-10-mutual-funds-for-2018
10.https://www.forbes.com/sites/robertlawton/2018/07/29/these-are-the-
top-10-mutual-funds-
! !289
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !290
EXOTIC INVESTMENTS
Chapter 7
Exotic Investments
Objectives:
This chapter will help you understand the various types of exotic
investments, which are special and may not be always done for trading or
in expectation of immediate returns.
Structure:
7.1 Introduction
7.2 Investments that are exotic : ART
7.3 Investments that are exotic : Diamonds
7.4 Investments that are exotic : Antiques
7.5 Investments that are exotic : Rare Books
7.6 Investments that are exotic : Clocks and Watches
7.7 Investments that are exotic : Vintage Cars
7.8 Investments that are exotic : Farm Houses
7.9 Investments that are exotic: Precious metals
7.10 Summary
7.11 Self Asessment Questions
7.12 References
! !291
EXOTIC INVESTMENTS
7.1 Introduction
Warren Buffett once mentioned, “Price is what you pay and Value is what
you get.” In the same way, some investors don't bother about the price
while purchasing a precious asset. The reason for this behavior is they care
more for value. Exotic investments means investing in real assets such as
art, jewelry, stamps, comic books, cards, or even automobiles which
appreciates in value over time because it is rare or it is desired by many.
Exotic investments are generally done by affluent investors who have lots
of money and are in always search of any asset which is rare and difficult
to acquire. The objectives behind investing in exotic investments vary
depending on the person and the collectible. It is often said that value lies
in the eyes of the beholder.
The value of diamonds as an investment is of significant interest to the

affluent as they are expensive and some of them very difficult to find.
Rarity is the big driver of classic car values.Many investors now a days
have been buying classic-car and otherwise prized automobiles as an
alternative to traditional investing.Antiques are bought to graceone’s home.
Antiques are great investments for people who have money they want to
put aside long-term. These investments are, however, very illiquid and
cannot be sold easily for want of a suitable buyer. The fine art market is
also booming. Every day we hear in the newspapers another auction record
is set for the highest price ever paid.Books,especially rare first editions are
a risk-free way to preserve wealth. Investing in rare books can be an
almost fool-proof way to hedge yourself against the volatility of the global
economic system. Rare books have historically proven to hold and
appreciate in value in the long run. Investing in Timepieces provide
emotional thrill. Knowledgeable collectors understand that unlike stocks or
bonds no two antique clocks are the same. The skill of the craftsmen, the
strength and popularity of the design and the results of a distinctive
history, frequently including at least one restoration, make each piece
unique and recognizing and appreciating these differences is essential.
The collectible market is a tricky one, and a lot of what people believe will
be valuable winds up becoming completely worthless. Hence before
investing in rare and precious exotic investments, the investor should take
care to find details and buy it from known dealers. Conceptual
understanding of time value of money and risk return relationship is
essential for making valuation judgments about real assets and collectibles.
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7.2 Investments that are exotic: ART
The rarity of a work of art is what gives it value, so an original will always
be worth more than a reproduction. Investors buy art because of love for
art and for aesthetic value.Most people who buy paintings don't end up
selling them later on.When a painting is auctioned, it's often because the
owner of the work thinks the piece will attract a handsome price. Art lovers
always visit museums, galleries and art institutions regularly to recognize
potential movers and shakers in their region. Prices rise because of the
popularity.
Investing in art requires some expertise to become successful. Buying of a

sculpture, oil painting or photograph that one likes should have potential
for increasing in value over time. Hence art investors must consult with art
experts before making any art investment purchases.
Investors should keep in mind the following points for buying of Art work:
• Look for the real art that is poured in the painting, including the
synchrony of strokes and colour
• Look for originality
• Buy Art from galleries that promote new artist s the price will be low
• Spread the risk among low priced new but promising painters
• Purchase paintings by painters who do not paint many canvasses
• Besides fetching good value in the future the Art work should be liked for
fixing at some prominent place at house or office
The sale of investment-grade artwork often requires the services of a

dealer or an auction house to realize full value.
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The value of the art depends upon various factors such as :
• the size of the edition (that is, the number of prints the artist makes of
one work);
• the significance of the work;
• the condition of the print; and
• whether it is signed and numbered by the artist.
The artwork changes each day but rarity bestows value. A low run of
limited edition prints is more valuable than a mass-produced image
India has been a land of rich in culture and religion. Art has been an very
integral force in our culture depicting various testimony to famous idols,
landmarks and manuscripts. Art is emerging as one of the more profitable
instruments of investment even in India.Artworks is used in various forms
such as a decor, portraits across doorways, guest rooms etc. Indian art is
getting great value in international markets. Nowadays art work can also
be bought online.
Advantages of investing in Art:
• Sense of personal satisfaction
• See and enjoy their investments daily
• The prices of rare art rise rapidly in the long run and it can act as a
tremendous hedge against inflation
• They don’t often lose value like their traditional counterparts in the
equities markets.
• There’s no risk in art investment equivalent to a company’s going out of

business.
• An artist’s output may be steady or sporadic, but immediately becomes

finite upon death or retirement, often leading to dramatic increases in
value.
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• Due to increase in international awareness about Indian Art it can fetch

good value in the future and rare art of India is still considered to be
underpriced in international markets
• Individual works can be loaned to museums, enhancing the investor’s

reputation and prestige.
• Investors who specialize in particular artists may find themselves

routinely invited to exhibits of their work and enjoy the opportunity to
meet the artist and mingle with fellow aficionados.
7.3 Investments that are exotic: Diamonds
The word Diamond comes from the Greek word ‘adamas’ which means
unconquerable and indestructible. Diamonds are tangible, portable and
considered to be of great value since the ancient times.
Diamonds popularity has increased because it is the most concentrated

store of value. Diamonds don't take up room. A diamond is durable as it
doesn’t break or wear off. Diamond is also considered as an excellent tool
to hedge against inflation. Its value is increasing because of improved
cutting and polishing techniques and larger awareness due to advertising.
Diamonds can be worn as well as used for investment purpose. And most
important it always stays in front of your eyes while you wear it and gives
emotional security.
The first lesson to be taken for investing in Diamond is to check the

4C’s.
Color
Cut 4C’s of Diamond Carat
Clarity
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Each diamond is unique and has specific qualities that establish its value.
The 4Cs of Diamond Quality is the universal method for assessing the
quality of any diamond.
Colour: The diamond color evaluation is based on the absence of color as

a chemically pure and structurally perfect diamond has no clour and
consequently, a higher value. Color is a result of the composition of the
diamond, and it never changes over time
Colorless diamonds are the most desirable since they allow the most
refraction of light (sparkle). Off white diamonds absorb light, inhibiting
brilliance.
The degree of colorlessness is measured by comparing the diamond under

controlled lighting.
Diamonds are graded with D-to-Z diamond color-grading system.

Diamonds graded D through F are naturally the most valuable and
desirable because of their rarity.
D is the best with least colour and Z is having the most colour.
Fancy color diamonds do not follow this rule. These colourdiamonds are
very rare and very expensive. Jewelers grade them as pink, red, blue,
yellow, brown or green. The pink diamond is the most expensive.
Clarity: Clarity refers to the absence of inclusions and blemishes. Natural

diamonds are the result of carbon exposed to tremendous heat and
pressure deep in the earth and hence can get a variety of internal
characteristics called ‘inclusions’ and external characteristics called
‘blemishes.’The diamond clarity is measured in terms of the number, size,
nature, and position of these characteristics. The visibility, number and size
of these inclusions determine the clarity of a diamond.Clear Diamonds
create more brilliance, and thus are more highly priced.
A Flawless (FL) diamond has no inclusions and no blemishes visible under

10x magnification. The closer it comes to the FL, the higher its value.
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Since diamond is extracted from nature, no diamond is perfectly pureand

contain some inner flaws, or inclusions, that occur during the formation
process. The different shades of clarity below FL are as follows:
Internally Flawless (IF) No inclusions visible under 10x magnification
Very, Very Slightly Included (VVS) Inclusions so slight they are difficult for
a skilled grader to see under 10x magnification
Very Slightly Included (VS) Inclusions are observed with effort under 10x
magnification
Slightly Included (SI) Inclusions are noticeable under 10x magnification
Included (I) Inclusions are obvious under 10x magnification which may
affect transparency and brilliance
Carat Weight: A carat is the unit of weight by which a diamond is

measured. The word "carat" is taken from the carob seeds that people
once used to balance scales as they were uniform in shape and weight.
Diamond carat weight measures a diamond’s apparent size. A metric

“carat” is defined as 200 milligrams or 0.2 grams. Each carat can be
subdivided into 100 ‘points.’ This allows very precise measurements to the
hundredth decimal place.A 2.02 carat diamond would be described as ‘two
point of two carats.
The price of a diamond rises exponentionaly to its size as large diamonds

are very rare. A 3 carat diamond will cost more than a 1 carat diamond.
Cut: Cut is probably the most important, and most challenging, of the four
Cs to understand. A diamond’s Cut unleashes Its light.A diamonds shape
may be round, heart, oval, marquise, pear but the cut will decide its ability
to transmit light and sparkle intensely. Here comes the skill, artistry and
workmanship to the diamonds into optimum proportions, symmetry and
polish in order to deliver the magnificent return of light. There can be a
ideal cut, fine cut, shallow cut or a deep cut diamond. A diamond cut can
create its width i.e diameter, a flat top called table, upper portion of a cut
called crown,narrow rim called girdle ,lower portion or base called pavilion,
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tiny facet on the pointed bottom called culet and height from the culet to
the table called depth.
In a poorly cut diamond, the light that enters through the table reaches the
facets and then 'leaks' out from the sides or bottom of the diamond rather
than reflecting back to the eye.
The diamond industry uses the word "cut" for shape e.g. emerald cut" and
to describe the reflective qualities of a diamond which depends on how well
the diamond is cut into proportions, symmetry and polish.
The optimum cut can create the following visual effects:
• Brightness due to reflection of Internal and external white light
• Fire effect created due to the scattering of white light into all the colors
of the rainbow
• Scintillation created due to the amount of sparkle produced and the

pattern of light and dark areas caused by reflections within the diamond
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The second lesson is to understand about the price transparency,

resale liquidity, market access, quality certification, and expert
guidance.
An investment diamond needs to be purchased at a price that is reasonably

close to the price that you can easily resell it. Large and expensive fancy
color diamonds attract the attention of super-wealthy collectors, they are
thinly traded and do not offer the price transparency or timely resale
liquidity.
The quality of the diamond should be ascertained through independent

third party grading and trustworthy expert confirmation.
Diamonds are very expensive and one must follow certain basic
rules before investing in Diamonds such as:
• Understand the 4 Cs of Diamond
• Be ready with the budgeted amount
• Decide what you want to buy: loose diamonds or diamond jewellery
• Choose diamonds which can be sold. The rarer the diamond the better
the investment
• Choose your jeweler as you choose your doctor
• Insist on a Diamond Grading Report by the country’s gemological society
• Purchase the diamonds of your choice
• Get the diamonds appraised and insured
• Hold them for years until they appreciate in value
Along with Diamonds, investors also invest in other precious stones such as
rubies, emeralds and sapphires due to their special colour appeal. Rubies
(red), Sapphires (yellow, blue) and Emeralds(green) are referred to as
colored precious stones. Investors will require special skill to identity the
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real ones and the appropriate value for it. However once bought its value is
going to appreciate without deterioration of the asset.
7.4 Investments that are exotic: Antiques
AN Antique is anything that is of historic interest or has been declared by

the government as antique. This could be sculpture, coins, objects,
childhood toys, Memorabilia chairs of forefathers, mid-century modern
furniture, Chinese and Japanese ceramics, vintage fashion bags or even
manuscripts. Antiques and collectibles have reached new heights of
popularity in recent years.
Every person should confirm that prior to the purchase of an antique

whether the antique is registered with registering officer of Archaeological
society of India.
Antiques are freely available in most Indian cities and one has to trust the
integrity of the seller Investment in antiques have several tax advantages
too. One can make tax free inome by selling antiques to museums and
collectors.
Factors that affect the price of antiques:
• Scarcity
• Demand
• Antiquity
• Nature
The real value of an antique is difficult to assess but the buying value lies
in the eyes of the beholder and the depth of the desire to possess it.
Antiques are bought for sheer joy of possessing as John Keats once said “
A thing of beauty is a joy forever”. However a heavy investment should not
be done in antiques if one’s aim is to generate regular income.
One should know the upsides and downsides of the antique before deciding
to buy it.
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Upsides can be:
• Growing rarity
• Not influenced by inflation or interest rate
• Rarely move in tandem with the economy and hence less volatile
• Do not factor into inheritance or capital gains tax
• Ability to capitalize on arbitrage situations
Main down sides can be:
• Real value is no known

• Maintenance can be costly for wine storage requires special rooms or
sensors to monitor moisture, heat, and light
• Wear and tear may result into decrease in value
• Unauthorized dealers may sell counterfeits
• Cannot be sold unless a buyer is willing to give the price the seller wants
6 Tips for Investing in Antique Furniture
• Research on the price

• Check the durability cycle of the vintage furniture: consider livability
• Understand the style and its worth. Ask your self a question: Does it
really belong to the royal family?
• Make sure about the authenticity of the material used
• The current condition should allow its survival for at least few years
• Buy something undervalued now before it becomes the next big thing
tomorrow : look beyond trends
Rules to follow for buying antiques

• Buy from established dealers
• Invest only in things you like
• Look for original and signed objects
• Follow your instincts
• Don’t buy damaged items :Chips, holes, and cracks tack away from the
value of an antique piece.
• Buy the bet you can afford :Pricing is typically subjective based on
current market trends
• Look for items with provenance
• Do not lavishly follow fashions
• Look for rare items
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• Beware of fakes: Signs of mass production include symmetrical

components
• Insure your collection: Protect your investment
7.5 Investments that are exotic: Rare Books
Books, especially the rare first editions are a risk-free way to preserve
wealth. Rare books represent a stable, long-term investment. A book’s
condition should be closer to the original condition. Equally important is a
book’s edition. The digital age could serve to make books even more
valuable because as published works become more ubiquitous in different
formats, collectors will be more driven to seek out original works.Experts
recommend to focus on rear books on a specific area interest, whether it’s
a particular author, genre or time period. Rare books can be bought out of
passion or for the same of making money. The main reason for buying a
book should be the pleasure it brings ; even though the other reasons is to
consider it as a potential investment.
People are becoming more aware of the rare books as a source of effective
investment instrument. We often hear stories about someone who spent
Rs50 at a flea market on an item that turned out to be worth Rs. 5 million.
Shakespeare First Folio can fetch multimillion dollar at an auction.
The down side of investing in rare book is there’s no liquidity and no fixed
prices.
Book trading websites such as Antiquarian Booksellers' Association and

AbeBooks allow you to view a wide range of books and the prices they
command.
The most sought-after books fetch thousands of rupees. However new

collectors have plenty of opportunities to purchase favourite reads in
editions that are still at collectable stage. For example as per the news
heard in the market, the first Penguin classic – Ariel by Andre Maurois in
top condition can payr up to £70. The second Penguin – A Farewell To Arms
by Ernest Hemingway published in 1935 sells for up to £120. Charles
Dickens1843 first edition iconic book A Christmas Carol with hand-coloured
illustrations by caricaturist John Leech can fetch £15,000.
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Steps for buying Rare books:
1. Old and valuable books are not displayed for one grab but one has to
have a lot of patience and time in hand to search for it.
2. Look for first edition especially if they are old and limited in number. An
early numbered edition if not the first edition can also fetch good value.
For e.g. a English book printed 50 years ago will fetch good price but a
book printed before the first world war would fetch double its value
3. Signature of the author on the book can be valuable
4. Determine the condition of the book and preservation techniques used
5. Negotiate to get the near real quality and pay the best price
7.6 Investments that are exotic: Clocks and Watches
A rare Patek Philippe watch from Eric Clapton’s collection was the star lot at
a Christie’s sale in Geneva at an estimate of £1.7 million to £2.6 million.
What does this mean?
Old watches and clocks are beginning to attract growing interest in Europe
and America. This tide is crossing the frontiers in India too.
Vintage is anything 25 years or older whereas ‘antique’ refers to anything

older than 100 years. Vintage wristwatches, screams out the character,
personality and the spirit of the age in which they were made. They are
wonderful talking points and always attract complimentary
remarks.Vintage watches are becoming a creditable investment pieces over
the years, offering extremely lucrative returns.The model must have had a
limited production run and the watch itself must be made from high-quality
unique materials. The exact age of some watches can be seen through
their serial numbers.
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!
Watches with mechanical movements are more collectible due to the time-
intensive crafting process required. However Quartz watches, powered by a
battery regulated crystal, can also be valuable if they are made from rare
materials or if it had a unique design unlike any other.
The real value of a watch depends on the scarcity and rarity of the
materials used. Hence one should try to figure out which materials are no
longer in circulation and whether the watches that use such materials are
rarer and therefore more valuable. For e.g. watches produced after 1985,
platinum is the most desirable material followed by a variety of different
golds.
In addition to the scarcity and rarity of material the brands of watch also
decide the value for e.g. watches manufactured by brand such as Rolex,
Hamilton and Omega are always popular and are set to increase in value.
Watches that were manufactured by brands no longer in production also
have a notable financial value as their availability will be lesser in number.
The condition of the watch can be impacted by its wear and tear which can
bring down its value.
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Steps to be taken for investing in old watch and clock:
1. Buy a book on old watch and clocks to read the details about watch
makers, specifications, identification marks and key attributes, what's
stamped on the dial, case metal,
2. Check the condition and see if there are repair opportunities as Vintage
watches are rather like classic cars. No vintage wristwatch will have a
degree of reliability even remotely approaching that of a brand new
model. After you buy it should continue to work
3. Luxury watches of yesteryear didn’t come with the technical features.

They neither provided protection against shock nor were water proof.
Hence no vintage wristwatch should ever be taken anywhere near water,
or even damp, today
4. Most collectors get around owning a variety of vintage watches in order

to ensure that at least some will work
5. Look for the real price, and the price for which is bought
7.7 Investments that are exotic: Vintage Cars
Vintage cars reminds us the grandeur of yesteryear to the days when the
rich indulged into accomplish any wish, desire or dream of theirs. The
Kings were eager to design and own an opulent, fantastic and most erotic
vehicle to suit their status and class. The rich Maharajas had cars built like
riding carriages, railway saloons, chariots and swans. The seats were
upholstered in tiger skins, in mink and in furs. Gold plating and diamond
encrusting was serving like an icing on a cake.
India still own a many of vintage cars of yesteryears due to the ban on its
exports in 1972.
The demand for vintage cars has jumped up nearly 500 percent. This is
possible because of availability of information at the finer tips through
internet. Information is also easily available from other collectors,
enthusiasts, even previous owners. People have become good investors in
vintage cars due to their extensive research.Identifying a particular make,
model and year will help an investor to know the real value of the vintage
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car. Classic cars date back at least 15 to 25 years while cars more than a
century old belong to a separate category of antiques.
Savvy investors with an affinity for rare, valuable objects have made
classic cars a valuable part of their portfolios.Vintage car collectors can
earn big returns on such vehicles. Besides earning good returns vintage car
owners find pride in experiencing the joy of owning and maintaining the
vehicle.
The popularity of vintage cars is evident from the skyrocketing prices that
cars are fetching at auctions.A 1955 Porsche 356 Pre-A Speedster by
Reutter had fetched 341,600 euros ($381,120) at RM Sotheby's Paris
auction. The car's relative scarcity i.e only 1,233 examples were built was
responsible to fetch such an astronomical figure. There was also a news
that a 1962 Ferrari 250 GTO got sold for a record price of $38.1 million and
a 1954 Mercedes-Benz racecar sold at public auction for a record $30
million.
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Here again investment in vintage car is done more out of pride and passion
to own it rather than making quick bucks on it.
One of the down side in owning a vintage car is its maintenance is very
costly. Parts are difficult to get and running costs are very high.
Steps to buy a Vintage Car
1. According to the Knight Frank Luxury Investment Index appreciation in

the value of classic cars has handily surpassed that of art, wine and
coins, all of which notched considerable gains themselves. Experts
believe that Vintage cars have been appreciating at about 35 percent
per annum. Hence first prepare your budget to buy. It can be a rich
mans hobby and not every ones coup of tea
2. Find out the pedigree i.e who is the maker of the car and the year of its
make
3. Ascertain the vehicles condition and availability of parts
4. Find out vehicle's previous owners, maintenance and travels
5. Ensure that the vintage car wasn’t in an accident
6. Find out the running expense, and other expenses such as insurance,
maintenance, restoration and storage
7. Vintage cars should be old and rare but they should also possess some
quality that makes them interesting to collect
8. Hire a certified appraiser or consultant to provide feedback on a

potential purchase who can can diagnose issues and save you money in
the long run.
9. Finally negotiate the best price considering the after sales expenses also
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7.8 Investments that are exotic: Farm Houses
A farmhouse is a type of a house, which serves a residential purpose in an

agricultural setting.It is surrounded by a farm or a well landscaped
garden.The farmhouses can have a design of a traditional or a modern
flavour but mostly have a rural and agri setting. Some farm houses are
also constructed with two stories and are seen as second homes and
weekend getaways. Buying a farm house is cheaper than buying a house in
a city. Most investors investing in a farmhouse buy it as per their need and
choice.
Farmland a not only a real asset that can generate revenues, but it is in
diminishing in supply around the world. It can produce any quantity of
output and hence it is getting increasing global demand. Owning a farm
house is become a trend for urban people who want to move out from the
vertical expansion of buildings and from the hustle bustle of urban areas.
Most urban investors in farm land are eager to spend some time in the lap
of nature. There is a sudden rush in investments on farm houses due to
cramped surroundings of modern urban India and inner urge to enjoy the
country side. The land buying options are aimed towards having a spacious
and comfortable house and converting into a farm house by fencing the
area and installing a gate to secure the land.
Many investors regard agriculture and farming investments as being

recession-proof. Real estate in India gives high return on investments.
Hence buying a farm house can serve dual purpose. One being returns in
the form of a weekend home/holiday home and enjoyment of organic food
and another appreciation in value.Investing in farm houses can serve as a
long-term investment and growth will come from cash flow through all
business cycles. Farmhouses are not just being used for residential
purposes, but also for using it for commercial purposes such as renting it
out for wedding parties, corporate events etc.
The farm house owner can not only expect safety of the principal amount
invested, but can also expect appreciation over a period of time and can
even dispose of a part of the huge land and keep the unused for better
ROI. 
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Steps to buy a farm house
1. Verify the marketable title of the seller/developer through some reliable

advocate in order to avoid future litigations
2. Check whether the land is fertile and there is source of water near by
like a river, well etc as well as the power
3. There should be easy access to the main roads and transport
4. The land should not be in a polluted region
5. Always visit the site personally and see it for your self whether it fits in
the dream of a second home before directly buying from the seller/
developer
6. You should be able to go and stay in the farm house periodically to

ensure proper maintenance
7. Execute a proper deed and get it registered before paying the

negotiated amount
8. Have security arrangement to look after the farm house
9. Enjoy the inspiring views, unwind and relax in fresh air in serene
atmosphere with sweet sounds and smells of nature
7.9 Investments that are exotic: Precious metals
Precious metals have a special place for investment in the minds of almost
all investors in India. Precious metals are precious because they are rare
and this is the very reason their value keeps on increasing as supply is not
able to match the demand.When investment demand is high, the price
tends to rise.
Gold is the most popular precious metal in the world not only amongst
individuals but also with industries and the government. Individuals are
interested to have gold in the ornamental due to its aesthetic
attractiveness, the industry for consumption due to its high resistance for
heat and the government for building foreign reserve to balance the import
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and exports payments. Investment in gold is also considered as a good

hedge against inflation. Investment in gold also provides aa good
diversification opportunity.
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Source:https://pixabay.com
Investing in Gold can happen in various forms:
1. Physical Gold: Investors buy gold from their jewellery shop during
festive occasions either in the form of jewellery or even in units of
grams as per their budget. However on sale, the proceeds can be taxed
as capital gains: short term capital gains if sold within 3 years of
purchase and long term capital gains if sold after 3 years. Investor may
not get the full value as some part of the gold ay be deducted as
impurity. Physical gold needs to be kept safely at home or at bank
lockers which can also involve cost.
2. Physical Gold: In the form of Gold coins , bars and Biscuits through
jewelers or banks. These are assured of purity and may have a higher
price than gold bought for making ornaments.
3. GoldETF: Those who don’t want to buy physical gold can invest in Gold
ETF through their demat account. Here buying and selling of Gold ETF
units will involve brokerage costs but there are no entry or exit loads.
Investor need not worry on deduction due to impurity nor for
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safekeeping. Gold ETFs are tax efficient as the capital gains are charged
at a lesser rate than physical gold.
4. Gold Funds: Investor can also invest in Gold funds launched by various
Mutual Funds through SIP. SIP will result in rupee cost averaging and in
the long run investor will benefit by paying a average price over a period
of time for the Gold.
5. Gold Futures: Gold futures can be leveraged on margin amount.

Investor has the option to square of the transaction or settle the
transaction on delivery basis.
6. Sovereign Gold Bonds: With the Government of India's I Sovereign

Gold Bonds investing in Gold has become easier and convenient. The
best part of this investment in Gold is Sovereign Gold Bonds gives an
assured return of 2.50% per annum and redemption is linked to Gold
Price. Interest on the Bonds shall be taxable as per the provisions of the
Income-tax Act, 1961. A special discount of Rs. 50 can also be availed
on online investment by retail investors. This type of investment
eliminates the risk of storage and investment is exempt from Capital
gains tax, if held till maturity. It has a tenor of 8 years with an option to
exit from the 5th year. The Bonds shall be denominated in units of one
gram of gold and multiples thereof. Minimum investment in the Bonds
shall be one gram with a maximum limit of subscription of 4 kg for
individuals. The Bonds may be used as collateral for loans.
Gold is traditionally weighed in troy ounces, but the proportion of gold is

measured on the Karat scale. Pure gold is designated as 24 carat. Investing
in Gold has various benefits as follows:
1. Hedge against inflation as its prices rise commensurate with inflation

2. Adds stability to portfolio as it is less volatile
3. Can be easily converted into cash hence offers liquidity
4. Gold can be purchased in various forms and suiting individual budet
5. Gold does not rust or decay
6. Gold adds to the status value
7. Gold can also be an excellent collateral for taking a loan or advance
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The three major precious metals that trade on futures exchanges around
the world are gold, silver, and platinum. Investing in silver can be more
affordable than gold. Most investors know that silver has precious value
and has helped investors to stabilize wealth over the long term. Even
though the price of the silver is volatile, it can be purchased as an
investment; like other precious metals.Platinum can be costlier than Gold
as it is believed that Platinum is almost 30 times rarer than gold. Platinum
is about 50% denser than gold and hence is much stronger than
gold.Platinum is naturally white, Gold is naturally yellow. Despite being
stronger and more durable, platinum is a softer metal and will get
scratched a little easier.
Steps to be followed by the Investor before investing in precious

metals
1. Decide which precious metal to buy and what is the purpose to buy
2. Research on the price and availability and decide which method to buy
3. Based on the investment method initiate the documentation and

payment
4. Monitor the prices periodically
5. Evaluate your portfolio and decide if any additions or deletions of

precious metals is to be doe from the portfolio
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7.10 Summary
Exotic investments are generally done by affluent investors who have lots
of money and are in always search of any asset which is rare and difficult
to acquire. The objectives behind investing in exotic investments vary
depending on the person and the collectible. It is often said that value lies
in the eyes of the beholder.
The collectible market is a tricky one, and a lot of what people believe will
be valuable winds up becoming completely worthless. Hence before
investing in rare and precious exotic investments, the investor should take
care to find details and buy it from known dealers. Conceptual
understanding of time value of money and risk return relationship is
essential for making valuation judgments about real assets and collectibles.
The rarity of a work of art is what gives it value, so an original will always
be worth more than a reproduction. Investors buy art because of love for
art and for aesthetic value. Investing in art requires some expertise to
become successful. The sale of investment-grade artwork often requires
the services of a dealer or an auction house to realize full value. The
artwork changes each day but rarity bestows value. Art is emerging as one
of the more profitable instruments of investment even in India. Artworks is
used in various forms such as a decor, portraits across doorways, guest
rooms etc. Indian art is getting great value in international markets.
Nowadays art work can also be bought online.
The first lesson to be taken for investing in Diamond is to check the 4C’s.
The diamond color evaluation is based on the absence of colour as a
chemically pure and structurally perfect diamond has no colour and
consequently, a higher value. Clarity refers to the absence of inclusions and
blemishes. A Flawless (FL) diamond has no inclusions and no blemishes
visible under 10x magnification. The closer it comes to the FL, the higher
its value. The price of a diamond rises exponentionaly to its size as large
diamonds are very rare. Cut is probably the most important, and most
challenging, of the four Cs to understand. A diamonds shape may be
round, heart, oval, marquise, pear but the cut will decide its ability to
transmit light and sparkle intensely.
The second lesson is to understand about the price transparency, resale

liquidity, market access, quality certification, and expert guidance.
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EXOTIC INVESTMENTS
An Antique is anything that is of historic interest or has been declared by

the government as antique. Every person should confirm that prior to the
purchase of an antique whether the antique is registered with registering
officer of Archaeological society of India.
Rare books represent a stable, long-term investment. People are becoming

more aware of the rare books as a source of effective investment
instrument. The down side of investing in rare book is there’s no liquidity
and no fixed prices.
Old watches and clocks are beginning to attract growing interest in Europe
and America. This tide is crossing the frontiers in India too. The real value
of a watch depends on the scarcity and rarity of the materials used. In
addition to the scarcity and rarity of material the brands of watch also
decide the value.
Savvy investors with an affinity for rare, valuable objects have made
classic cars a valuable part of their portfolios. Vintage car collectors can
earn big returns on such vehicles. Besides earning good returns vintage car
owners find pride in experiencing the joy of owning and maintaining the
vehicle. Investment in vintage car is done more out of pride and passion to
own it rather than making quick bucks on it. One of the down side in
owning a vintage car is its maintenance is very costly. Parts are difficult to
get and running costs are very high.
Many investors regard agriculture and farming investments as being

recession-proof. Real estate in India gives high return on investments.
Hence buying a farm house can serve dual purpose. One being returns in
the form of a weekend home / holiday home and enjoyment of organic
food and another appreciation in value. Investing in farm houses can serve
as a long-term investment and growth will come from cash flow through all
business cycles.
Precious metals have a special place for investment in the minds of almost
all investors in India. Precious metals are precious because they are rare
and this is the very reason their value keeps on increasing as supply is not
able to match the demand.
! !314
EXOTIC INVESTMENTS
1. What are exotic investments?
2. Why do the investors buy Art?
3. Investors should keep in mind which points for buying of Art work?
4. The value of the art depends upon which factors?
5. What re the advantages of investing in Art?
6. Explain the 4 C’s to be considered before investing in diamonds?
7. Diamonds are very expensive and hence investors must follow which
basic rules before investing in Diamonds?
8. What is an antique. Describe different types of antiques.
9. Which factors that affect the price of antiques?
10. What are the upsides and downsides of investing in antique?
11. What are the rules to follow for buying antiques?
12. What are the basic steps for buying Rare books?
13. What are the basic steps to be taken for investing in old watch and
clock?
14. What are the basic steps to be taken to buy a Vintage Car?
15. What are the advantages of investing in farm houses?
16. What are the basic steps to be taken to buy a farm house?
17. What are the various ways in investing in Gold?
18. What are the various benefits of investing in Gold?
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EXOTIC INVESTMENTS
19. What are the steps to be taken by the Investor before investing in
precious metals?
Multiple Choice questions
1. Art is emerging as one of the more profitable instruments of investment

even in India. Artworks is used in various forms such as a decor,
portraits across doorways, guest rooms etc. Indian art is getting great
value in international markets. Which of the following is an advantage of
investing in ART?
a. Sense of personal satisfaction
b. The prices of rare art rise rapidly in the long run and it can act as a
tremendous hedge against inflation
c. They don’t often lose value like their traditional counterparts in the
equities markets
d. All of the above
2. Each diamond is unique and has specific qualities that establish its
value. The 4Cs of Diamond Quality is the universal method for assessing
the quality of any diamond. Which of the following is not a part of 4 Cs
of Diamond Quality?
a. Cut
b. Carat weight
c. Colour
d. Composure
3. The real value of a watch depends on the scarcity and rarity of the
materials used. Vintage wristwatches, screams out the character,
personality and the spirit of the age in which they were made. Vintage
means how many years older?
a. 5
b. 10
c. 25
d. 50
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EXOTIC INVESTMENTS
4. According to the Knight Frank Luxury Investment Index appreciation in

the value of classic cars has handily surpassed that of art, wine and
coins, all of which notched considerable gains themselves. Experts
believe that Vintage cars have been appreciating at about
a. 10 percent
b. 35 percent
c. 60 percent
d. 80 percent
5. A farmhouse is a type of a house, which serves a residential purpose in

an agricultural setting. It is surrounded by a farm or a well landscaped
garden. The farmhouses are designed in varied manners from traditional
to modern but mostly have a rural and agri setting. State whether the
above statement is true or false.
a. True
b. False
Ans: 1 - (d), 2 - (d),3 - (c), 4 - (b), 5 - (a)
! !317
EXOTIC INVESTMENTS
7.12 References
1. Investing in Income Properties: The Big Six Formula for Achieving

Wealth in Real Estate by Kenneth D. Rosen and Brian Holsopple
2. The Investor's Guidebook to Alternative Investments: The Role of

Alternative Investments in Portfolio by Stuart R. Veale
3. Alternative Investments: A Primer for Investment Professionals by

Donald R. Chambers and Keith H. Black
4. The Handbook of Professionally Managed Assets: A Definitive Guide to

Profiting from Alternative Investments by Keith R. Fevurly
5. The Handbook of Traditional and Alternative Investment Vehicles:

Investment Characteristics and Strategies by Mark J. P. Anson (Author),
Frank J. Fabozzi (Author), Frank J. Jones (Author)
6. The Artful Dodger: Collecting and investing in fine art without a spare
million in pocket change by Leonard D. DeMaioKsmaKcosa
7. Investing in Antique Silver Toys and Miniatures by William G. Jackman

and Martin Noble
8. How To Deal In Antiques by Fiona Shoop
9. The 101 on Collecting and Investing in Books by Ross Maclean
! !318
EXOTIC INVESTMENTS
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !319
MODERN INVESTMENT ALTERNATIVES
Chapter 8
Modern Investment Alternatives
Objectives:
This chapter will help you understand the basics of derivatives , different
types of derivatives contracts, the participants in the derivatives markets
as well as the different applications of derivatives contract.
Structure:
8.1 Introduction
8.2 Types of Derivative Contract
8.3 Participants in the Derivatives Market
8.4 Risks Associated with Derivatives
8.5 Commercial usage of Derivatives
8.6 Summary
8.8 References
! !320
8.1 Introduction
Derivative is a product whose vale is derived from the value of one or more
basic variable called the underlying e.g equity, forex, commodity or any
other asset
Derivatives are hedging instruments which can be used in all environments

that generate risk. Investors use derivatives to hedge risk and trade.
Derivatives can also be used for speculation or arbitrage. Speculators use
price movements to make short term profits and Arbitrageurs derive profit
from differences in prices of an asset in two different markets. Derivatives
can be used to make profits from the volatility in the prices of the stocks,
indices, commodities, currency. The derivatives market is bigger than the
stock market in terms of underlying assets.
Dojima rice futures market set up in 1730 in Osaka, Japan is considered as

worlds first futures market. The Chicago Board of Trade (CBOT) listed the
first-ever standardized 'exchange traded' forward contracts in 1864 on
grain trading. International Monetary Market (IMM) is the world's first
financial futures exchange created in 1972 It launched currency futures in
1976 and added interest rate futures on US treasury bills and stock market
index future in 1982.
Derivatives market emerging as major force in financial markets in early

1970s due to:
1. Failure of Brettonwood System
2. Breaking of the fixed exchange rate regime
3. New exchange rate regime, i.e., floating rate (flexible) system based
upon market forces
4. New pressure of demand and supply on different currencies, and

fluctuation in short term interest rates
5. Exchange rates constantly changing
6. Business firms faced a new risk, known as currency or foreign exchange

risk.
! !321
7. New financial instrument in the form of derivative was developed to

overcome this risk in the new financial environment.
Speculators soon became interested in the contract and found trading the
contract to be an attractive alternative to trading the grain itself.
Derivative market in India is believed to be in existence since the ancient

times. It carried out the operations similar to the modern day Futures
market . Futures market in its organized form appeared only in the late
19th century, with the advent of the British.
The first organised futures market was established in 1875 by the Bombay
Cotton Trade Association to trade in cotton contracts. The subject of
futures trading was placed in the Union list when the Constitution of India
was framed. The Government of India had banned futures trading on
commodities to prevent speculation on agri prices.
Dr. L C Gupta committee was set up to study the feasibility of introduction

of derivative contracts in Indian markets in wake of liberalization of Indian
economy in 1991.
In April 1999 , the Government of India decided to remove all the

commodities from the restrictive list for futures trading. Derivatives was
included within the domain of ‘securities’ in the Securities Contract
Regulation Act (SCRA), 1956 in 1999. New regulatory framework was
developed for governing derivatives trading. SEBI is the derivative market
regulator and is vigilant to any manipulation by any mishap players
Government also allowed setting up of new modern, demutualized

Nationwide Multi-commodity Exchanges with investment support by public
and private institutions. National Multi Commodity Exchange of India
Limited (NMCE) was the first such exchange to be granted permanent
recognition by the Government.
Exchange traded financial derivatives were introduced in India in June 2000

at the two major stock exchanges, National Stock Exchange (NSE) and
Bombay Stock Exchange (BSE). Both BSE and NSE were permitted by SEBI
to introduce equity derivative segment. Trading in index futures contracts
based on Nifty and Sensex commenced first in 2000. Trading in Index
options and futures contracts on individual stocks commenced in 2001.
! !322
Interest rates futures introduced with notional Treasury Bills and 10 years
bonds in 2003. Trading in currency futures was started at both NSE and
BSE in 2008.Bond futures was introduced in 2009 and Currency options in
2010. Securities and Exchange Board of India has recently permitted
commodity derivative exchanges to launch options contracts for trading
with the aim of increasing liquidity and attracting more investors to the
commodities market. Commodity options can facilitate hedging by market
participants and help deepen the commodity derivatives market.
The derivative market in India, is increasingly gaining significance.
8.2 Types of Derivative Contract
Derivatives are one of the three main categories of financial instruments,

the other two being stocks (i.e., equities or shares) and debt (i.e., bonds
and mortgages).
There are two types of Derivatives
(a) Commodity Derivative

(b) Financial Derivative
In a commodity derivatives, the underlying instrument is a commodity

which may be wheat, cotton, pepper, sugar, jute, turmeric, corn,
soyabeans, crude oil, natural gas, gold, silver, copper and so on.
Commodity Derivatives can be classified as following underlying:
• Energy (including crude oil, heating oil, natural gas and gasoline)
• Metals: Precious Metals: Gold, Silver, Platinum, etc, Other Metals:

Nickel, Aluminum, Copper, etc
• Livestock and Meat (including lean hogs, pork bellies, live cattle and
feeder cattle)
• Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee,

cotton and sugar) Soft Commodities: Coffee, Cocoa, Sugar, etc
! !323
In a financial derivative, the underlying instrument may be treasury

bills, stocks, bonds, foreign exchange, stock index, gilt-edged securities,
cost of living index, etc. Financial derivative generally does not have quality
issues whereas Commodity derivatives may have quality issues while
trading with the underlying.
Derivatives can be classified into two main types on the basis of

instruments:
a. Basic Derivatives: forward contracts, futures contracts, option

contracts, warrants and convertibles
b. Complex Derivatives: Swaps and other exotic non-standard

contracts
Forward contact
A forward contract is a simple customized contract between two parties to

buy or sell an asset at a certain time in the future for a certain price.
In a Forward contact settlement takes place on a specific date in the future

at today’s pre-agreed price. for e.g a merchant agrees to buy rice at Rs. 50
per Kg after 3 months.
They are traded Over The Counter(OTC) i.e. outside the stock exchanges,
directly between the two parties
A forward contract trade may suffer from counter party risk as they do not
come under the purview of rules and regulations of an exchange.
The basic features of a forward contract are as follows
a. Forward contracts are bilateral contracts
b. Exposed to counter-party risk
c. Each contract is custom designed
d. One of the parties takes a long position by agreeing to buy the asset
at a certain specified future date where as the other party assumes a
! !324
short position by agreeing to sell the same asset at the same date for
the same specified price.
e. Specified price in a forward contract is referred to as the delivery

price.
f. Derivative assets can often be contracted from the combination of

underlying assets (synthetic assets)
g. Contract has to be settled by delivery of the asset on expiration date.
h. Forward contracts are very popular in foreign exchange market as

well as interest rate bearing instruments.
i. As per the Indian Forward Contract Act-1952, different kinds of

forward contracts can be done like hedge contracts, transferable
specific delivery (TSD) contracts and non-transferable specify delivery
(NTSD) contracts.
j. Transacted over-the-counter and is not traded on an exchange.
Forward contracting can be used in hedging and speculation as

follows
Hedging process
A wheat farmer can sell his harvest at a known price in order to eliminate
price risk in the future. Similarly, a bread factory can buy bread forward in
order to assist production planning without the risk of price fluctuations.
Speculation process
A speculator keep a close watch on the demand and supply situation in the
market and believes there will a rise in price of a commodity in the future.
Hence in the forward market the speculator would go long on the forward,
wait for the price to rise, and then take a reversing transaction making a
profit
The value of a forward position at maturity depends on the relationship

between the delivery price (K) and the underlying price (ST) at that time.
! !325
The payoff from a long position in a forward contract (long forward

contract) on one unit of its underlying asset or commodity is:
Payofflong = ST – K
where: ST is the spot price of the underlying at maturity of the contract

and K is the delivery price agreed in the contract.
The holder of the long position is obligated to buy the underlying,

trading at sport price ST, for the delivery price K.
The holder of the short position is obligated to sell the underlying, trading
at spot price ST, for the delivery price K.
Futures contract
A futures contract is an agreement between two parties to buy or sell an

asset at a specified time in the future for a specified price through an
exchange.
The terms of the agreement such as the quantity of the asset, the quality
of the asset, the delivery date or period, and the delivery location are
specified by the exchange.
Pricing of a futures contract depends on the characteristics of underlying

asset. It is generally done through the Cash and Carry Model for Futures
Pricing.
Buyers of futures contracts are considered to have a long position,

whereas, sellers are considered to have a short position.
There is no counterparty risk as all trades are guaranteed by the clearing

corporation.
A margin of 5% to 15% of the contracts value is taken from both the

parties and monitored on a daily basis by the exchange to mitigate risk. As
the contract approaches its expiry, the spot price and futures price would
converge i.e. Futures price minus Spot price would become zero.
! !326
The basic features of a future contract are as follows
a. Standardized specification, i.e., quantity of the asset, quality of the

asset, the date and month of delivery, the units of price quotation,
location of settlement, etc.
b. Exchange clearing house gives the guarantee of the performance of the

contract to each party
c. Settlement price is used to compute the profit or loss on each contract

for that day as each contract is marked to market.
d. Daily settlement and margin requirements to act as a collateral security

and minimize risk of failure of either party
e. Expressed in currency units, with a minimum price movement called a

tick size and rounded to nearest tick
f. Settled in cash by having a short or long position
g. Executed on expiry date
h. Counter party with long position are obligated to make delivery to the
exchange
i. Exchange is obligated to make delivery to the longs
j. Regulated through the exchange
Pay off for buyer of futures: The potential profit/ loss at expiry when
expressed graphically, is known as a pay off
The profits and losses for the short futures position will be exactly opposite
of the long futures position
! !327
Applications of Futures
1. Hedgers such as Banks, Financial Institutions etc use Futures contract to

hedge or reduce their exposures to market variables such as interest
rates, share values, bond prices, currency exchange rates and
commodity prices.
2. The speculators uses futures contract to create a speculative position by

buying the physical commodity. The traders prefer to go long futures
contract on the underlying asset. Both happens in a scenario where both
the speculators and the traders feel that increasing demand or scarce
production is likely to boost the price of a commodity
3. A futures contract is used by arbitragers to exploit a mispricing of

commodities in the market An arbitrage occurs when a trader purchases
an asset cheaply in one location/ exchange and simultaneously arranges
to sell it at another location/exchange at a higher price to book profits.
Difference between Forward and Future contract

Basis Forward Future
Nature Traded on Over the Counter Exchange Traded
Contract Term Customized Standardized

Liquidity Less liquid More liquid
Margin payment Not required Requires margin payment
Settlement At the end of the period. Follows daily settlement
Squaring off Same counter-party with Any member of the Exchange

whom it was entered into.
Counter party risk Exists Does not exist ; Guaranteed
by exchange
! !328
Options
An Option contract is an agreement between two parties whereby one

party obtains the right, but not the obligation, to buy or sell a particular
asset, at a specified price, on or before a specified date. The person who
acquires the right is known as the option buyer or option holder. The
person who confers the right is known as option seller or option writer. The
seller of the option for giving such option to the buyer charges an amount
which is known as the option premium.
Writing Options
The seller of an option is known as the writer of an option.
Writer of an option have a short position.
The profit (loss) profile at expiry of a short option is exactly opposite of a

long position. Hence the profit of the buyer is the loss of the seller and vice
versa.
The buyer of a call option has a loss potential that is limited to the
premium paid but an unlimited potential for profit.
The writer of a call has a maximum profit equal to the premium received,
but the loss potential is unlimited
Options are traded both on exchanges and in the over-the-counter market.

The largest exchange in the world for trading stock options is the Chicago
Board Options Exchange
Options can be classified into the following two main types:

(a) Call
(b) Put
A call option gives the holder the right to buy the underlying asset by a
certain date for a certain price. A put option gives the holder the right to
sell the underlying asset by a certain date for a certain price.
! !329
The price in the contract is known as the exercise price or strike price', the
date in the contract is known as the expiration date or maturity. The asset
or security instrument or commodity covered under the contract is called
as the underlying asset.
Buyers are referred to as having long positions', sellers are referred to as

having short positions.
In India, the banks are allowed to write cross-currency options after

obtaining the permission from the Reserve Bank of India.
Seller of the option is under an obligation
The seller of the option (the option writer) is under an obligation and not
the buyer of the option (the option purchaser).
In a call option, the buyer of the option has the right to BUY the
underlying
In a put option, the buyer of the option has the right to SELL the
underlying
Option buyer may or may not exercise his right
In case the buyer of the option does exercise his right, the seller of the
option must fulfill whatever is his obligation (for a call option, the option-
seller has to deliver the asset to the buyer of the option; for a put option
the option-seller has to receive the asset from the buyer of the option).
Option Styles
European Option Contracts: If the option was to be exercised on a

specific date ie. 1 month down the line (settlement date, at the end of the
contract period). Such options are known as European option contracts.
American Option Contracts: If the option could be exercised anytime up

to the expiry of the contract period. Such option are known as American
option contracts.
! !330
Bermudan Option Contracts: This type of option can be exercised only

on certain pre-decided dates and are a combination of American and
European options. They are exercisable at the date of expiration, and on
certain specified dates that occur between the purchase date and the date
of expiration.
Asian option Contract: An option whose payoff is determined by the

average underlying price over some preset time period.
Barrier option: A option with the general characteristic that the

underlying security's price must pass a certain level or barrier before it can
be exercised.
Binary option: An all-or-nothing option that pays the full amount if the
underlying security meets the defined condition on expiration otherwise it
expires.
Exotic option: An option have a combination of various option contract

features and is of a broad category of options that may include complex
financial structure
Options can be any of the following types:
a. In the Money Option: Enables investor to sell or exercise it for

profit.
Would lead to a positive cash flow to the holder if it were exercised

immediately.
A call option on the index is said to be in-the-money when the current

index stands at a level higher than the strike price.
A put is said to be In-the-money if the index is below the strike price.
b. Out of the Money Option: Stock or index option is in loss in the

form of premium paid to buy the option.
An out-of-the-money (OTM) option would lead to a negative cash flow if it

were exercised immediately.
! !331
A call option on the index is out-of-the-money when the current index

stands at a level which is less than the strike price.
c. At the Money Option: Option's strike price is identical to the

price of the underlying security and there is no scope to earn
profit
An at-the-money (ATM) option would lead to zero cash flow if it were

exercised immediately.
An option on the index is at-the-money when the current index equals the
strike price.
Options Payoff matrix
Option contracts have non-linear or asymmetrical payoffs i.e. the losses

and profits for the buyer and the seller of an options contract do not follow
a straight line.
One party (option buyer) to the contract can have unlimited upside, while
limiting its downside (to the option premium); losses of the other party
(option seller) can be unlimited, for a limited upside (option premium).
Various forms of Options Payoff matrix
a. Long Call: A trader who expects a stock's price to increase can buy a
call option to purchase the stock at a fixed price ("strike price") at a
later date, rather than purchase the stock outright. Profit is made if spot
price exceeds strike price.
b. Long Put: A trader who expects a stock's price to decrease can buy a
put option to sell the stock at a fixed price ("strike price") at a later
date.
c. Short Call: A trader who expects a stock's price to decrease can sell
the stock short or "write" a call.
d. Short Put: A trader who expects a stock's price to increase can buy the
stock or "write" a put.
! !332
Options Strategies
Options strategies are formed by combining any of the four basic kinds of
option trades with different exercise prices and maturities. An investor can
follow the following various types of options strategies to make profits:
a. Butterfly spread: A combination of Long one call, Short two calls, and
Long one call allows a trader to profit if the stock price on the expiration
date is near the middle exercise price and does not expose the trader to
a large loss.
b. Iron condor: Similar to a butterfly spread, but with different strikes for
the short options
c. Straddle: Selling both a put and a call at the same exercise price would
give a trader a greater profit than a butterfly if the final stock price is
near the exercise price
d. Strangle: Similar to the straddle as it is also constructed by a call and a

put but with different strikes
e. Covered call: Trader buys a stock (or holds a previously-purchased

long stock position), and sells a call. If the stock price rises above the
exercise price
f. Protective put: Trader buys a stock (or holds a previously-purchased

long stock position), and buys a put.
Difference between Futures and Options
Option gives the holder the right to do something. The holder does not
have to exercise this right.
In case of forwards and futures, the holder is obligated to buy or sell the
underlying asset.
Investor does not have to incur any cost to buy a Forward or futures
contract but there is a cost to acquiring an option.
! !333
Currency Futures
A currency future is also known as FX future, is a futures contract to

exchange one currency for another at a specified date in the future at a
price (exchange rate) that is fixed on the purchase date.
Currency future contracts allow investors to hedge against foreign

exchange risk.
On NSE the price of a future contract is in terms of INR per unit of other
currency. The National Stock Exchange permits Currency future on four
currency pairs viz. US Dollars (USD), Euro (EUR), Great Britain Pound
(GBP) and Japanese Yen (JPY) and Interest Rate Futures on 10 Y GS 7 and
91 D T-Bill.. Currency options are currently available on US Dollars.
Currency futures on USD-INR were introduced for trading and subsequently
the Indian rupee was allowed to trade against other currencies such as
euro, pound sterling and the Japanese yen The exchange launched its
currency futures trading platform on 29th August, 2008. Currency Options
was introduced on October 29, 2010.
An investor that expects a currency to become strong will buy currency

futures. If the investor expects the currency to weaken will sell currency
futures.
Clearing and Settlement: National Securities Clearing Corporation

Limited (NSCCL) is the clearing and settlement agency for all deals
executed on the Currency Derivatives segment. NSCCL acts as legal
counter-party to all deals on NSE's Currency Derivatives segment and
guarantees settlement.
! !334
Options Contract Specifications ( Source: https://

www.nseindia.com)
Symbol USDINR EURINR GBPINR JPYINR
Market Type N N N N
Instrument FUTCUR FUTCUR FUTCUR FUTCUR

Type
Unit of 1 - 1 unit 1 - 1 unit 1 - 1 unit 1 - 1 unit
trading denotes 1000 denotes 1000 denotes 1000 denotes
USD. EURO. POUND 100000
STERLING. JAPANESE
YEN.
Underlying/ The exchange The exchange The exchange The exchange

Order rate in Indian rate in Indian rate in Indian rate in Indian
Quotation Rupees for US Rupees for Rupees for Rupees for
Dollars Euro. Pound 100 Japanese
Sterling. Yen.
Tick size 0.25 paise or INR 0.0025
Trading Monday to Friday  

hours 9:00 a.m. to 5:00 p.m.
Contract 12 month trading cycle.
trading cycle
Last trading Two working days prior to the last business day of the expiry
day month at 12:30 pm.
Final Last working day (excluding Saturdays) of the expiry month.  
settlement The last working day will be the same as that for Interbank
day Settlements in Mumbai.
Quantity 10,001 or greater

Freeze
Base price Theoretical Theoretical Theoretical Theoretical
price on the price on the price on the price on the
1st day of the 1st day of the 1st day of the 1st day of the
contract.  contract.  contract.  contract. 
On all other On all other On all other On all other
days, DSP of days, DSP of days, DSP of days, DSP of
the contract. the contract. the contract. the contract.
! !335
Price Tenure upto +/-3 % of base price.

operating 6 months
range
Tenure +/- 5% of base price.
greater than
6 months
Position Position Limits for CDS Segment

limits
Initial SPAN Based Margin
margin
Extreme loss 1% of MTM 0.3% of MTM 0.5% of MTM 0.7% of MTM

margin value of gross value of gross value of gross value of gross
open position open position open position open position
Calendar Rs. 400 for Rs. 700 for Rs. 1500 for Rs. 600 for
spreads spread of 1 spread of 1 spread of 1 spread of 1
month Rs. 500 month  month  month 
for spread of 2 Rs. 1000 for Rs. 1800 for Rs. 1000 for
months  spread of 2 spread of 2 spread of 2
Rs. 800 for months  months  months 
spread of 3 Rs. 1500 for Rs. 2000 for Rs. 1500 for
months   spread of 3 spread of 3 spread of 3
Rs. 1000 for months and months and months and
spread of 4 more more more
months and
more
Settlement Daily settlement : T + 1  

Final settlement : T + 2
Mode of Cash settled in Indian Rupees
settlement
Daily Calculated on the basis of the last half an hour weighted

settlement average price.
price 
(DSP)
! !336
Final RBI reference RBI reference Exchange rate Exchange rate

settlement rate rate published by published by
price  RBI in its RBI in its
(FSP) Press Release Press Release
captioned RBI captioned RBI
reference Rate reference Rate
for US$ and for US$ and
Euro Euro
Warrants and Convertibles
Warrant is just like an option contract where the holder has the right to
buy shares of a specified company at a certain price during the given time
period.
The holder of a warrant instrument has the right to purchase a specific

number of shares at a fixed price in a fixed period from a issuing company.
If the holder exercised the right, it increases the number of shares of the
issuing company, and thus, dilutes the equities of its shareholders.
Warrants can be issued along with debt instruments and can be detached
and traded separately. Expiry dates is more than 5 years from issue date.
Warrants are said to be in-the-money when market price is greater than

the exercise price.
Convertibles: Convertibles are hybrid instruments which gives a choice

between bonds and shares. They combine the basic attributes of fixed
interest and variable return securities e.g. convertible bonds, convertible
debentures and convertible preference shares. These are also called equity
derivative securities. They can be fully or partially converted into the equity
shares of the issuing company at the predetermined specified terms with
regards to the conversion period, conversion ratio and conversion price.
The number of shares for which the convertible bond can be exchanged is
called the conversion rate.
Excess of market value over investment value is called option premium
! !337
Swaps
Swaps are private agreements between two parties to exchange cash flows
in the future.
Swaps were first introduced to the public in 1981 when IBM and the World
Bank entered into a swap agreement. Swaps are among the most heavily
traded financial contracts in the world. Most swaps are traded over-the-
counter (OTC),tailor-made for the counterparties.
The agreement defines the dates when the cash flows are to be paid and
the way in which they are to be calculated. It also specifies the future value
of an interest rate, an exchange rate, or other market variable.
Unlike a forward contract where cash flows happens on just one future
date, swaps lead to cash flow exchanges on several future dates.
Swaps have a longer Maturity term than other derivatives like futures or
options.
The two commonly used swaps are:

(a) interest rate swaps and
(b) currency swaps.
(a) Interest rate swaps (IRS)
In an interest rate swap two parties agree to exchange interest rate cash
flows, based on a specified notional amount from a fixed rate to a floating
rate (or vice versa)
One party agrees to pay cash flows equal to interest at a predetermined

fixed rate on a notional principal for a predetermined number of years. In
return, it receives interest at a floating rate on the same notional principal
for the same period of time.
For e.g. A will pay 9% pa onRs.500crores for next 3 years and it receives
BOB-MCLR on Rs.500 crores for next 3 years from B.
Thus A is protected from future increases in interest rate and thus

transform his liability.
! !338
Uses of Interest rate swaps

• Risk management
• Portfolio management
• Corporate finance
• Rate locks
• Speculation
(b) Currency Swaps
A currency swap is a foreign exchange derivative between two institutions.

These two parties agree to exchange both principal and interest payments
of loan in one currency for equivalent amount in net present value terms in
another currency.
Currency swaps has many uses like
• to secure cheaper debt

• to hedge against forward exchange rate fluctuations
• to defend against financial turmoil due to liquidity crisis
Stock Market Indices
A stock index is an indicator of the performance of overall market. Index is

prepared by giving to each stock according to its market capitalization.
Higher market capitalization stock get higher weight in the index. Index
can also be calculated by Equal Weighted, Price-Weighted and Free-Float
Market Capitalization method. NSE indices are managed by India Index
Services and Products Ltd.
Major Indices in India

• S&P BSE Sensex
• S&P BSE Midcap
• S&P BSE 100
• S&P BSE 200
• S&P BSE 500
• Nifty
• Nifty Next 50
• Nifty 100
• Nifty 200
• Nifty 500
! !339
Application of Index
Index funds invest in a stock in proportion to which these stocks exist in

the index with an objective to generate returns equivalent to the return on
index.
Index Derivatives are derivative contracts which have the index as the
underlying asset. They are used to to hedge against the market risk
through a Index Options and Index Futures derivative contracts.
Exotic or Non-standard Derivative
Forwards, futures, options, swaps, etc. are described usually as standard

or ‘plain vanilla’ derivatives. In the early 1980s, some banks and other
financial institutions have been very imaginative and designed some new
derivatives to meet the specific needs of their clients. These derivatives
have been described as ‘non-standard’ derivatives.
Non-standard derivatives were formed by combining two or more ‘plain

vanilla’ call and put options whereas some others were far more complex.
Since there are no fixed specifications, these derivative products are also
called exotic derivatives.
Examples of non-standard derivatives: forward start option, compound

options, choose options, barrier options, binary options, look back options,
shout options, Asian options, basket
Look-back options: Gives the right to buy at the lowest price traded
during the life of the option and right to sell at the highest price.
Option on an Option: Take out an option to buy an option on the date on

which first option contract is due to be bought or sold.
! !340
8.3 Participants in the Derivatives Market
Derivatives markets are attracted by different types of traders namely:
(a) Hedgers
(b) Speculators (Margin traders, Day traders, Position traders)
(c) Arbitrageurs
a. Hedgers use futures or options markets to reduce or eliminate the risk

associated with price of an asset. They try to hedge the price of their
assets by undertaking an exact opposite trade in the derivatives market.
b. Speculators use futures and options contracts to get extra leverage in

betting on future movements in the price of an asset.
c. Arbitrageurs are in business to take advantage of a discrepancy

between prices in two different markets. Very small arbitrage
opportunities are observed in the prices that are quoted in most
financial markets. As soon as an opportunity is seen arbitrageurs get
out of line to take offsetting positions in the two markets to lock in a
profit
Hedging example: Investor has 1000 shares of MAST Ltd. Market price is
Rs. 110 at present.
Goal: Sell these shares in six months.
Worry: Price of these shares could fall considerably by then.
Problem: Do not want to liquidate the investment today, as the stock has
a possibility of appreciation in the near-term.
Objective of holding: Like to receive a minimum of Rs.100 per share and

no less. At the same time, in case the price rises above Rs. 100, you would
like to benefit by selling them at the higher price.
Solution: Hedging: By paying a small price, investor can purchase a

derivative contract called an 'option' that incorporates all your above
requirements. Investor is thus, hedging his risks, and transferring them to
someone who is willing to take these risks.
! !341
In the derivative market, there will be a speculator who expects the market
to rise. For every opportunity that the derivative market offers a risk-
averse hedger, it offers a counter opportunity to a trader with a healthy
appetite for risk.
Hedging can be done using Forward contracts and Options
Forward contracts helps the investor to get a fixed price from the hedger
and reduce the risk of adverse price movement that the hedger.
Options contracts helps the investors to protect themselves against

adverse price movements in the future while still allowing them to benefit
from favorable price movements
Different types of Speculators
A day trader tries to take advantage of intra-day fluctuations in prices. All

their trades are settled by undertaking an opposite trade by the end of the
day. They do not have any overnight exposure to the markets.
A position trader greatly rely on news, tips and technical analysis – the
science of predicting trends and prices, and take a longer view, say a few
weeks or a month in order to realize better profits. They take and carry
position for overnight or a long term.
A Margin trader: Many speculators trade using of the payment

mechanism unique to the derivative markets. This is called margin trading.
When you trade in derivative products, you are not required to pay the
total value of your position up front. . Instead, you are only required to
deposit only a fraction of the total sum called margin. This is why margin
trading results in a high leverage factor in derivative trades.
Speculators use both Futures and Options
In case of Futures, the potential loss as well as the potential gain is very
large.
In case of Options, loss is limited to the amount paid for the options
! !342
Types of Derivatives Market
Derivatives markets are of two types:

(a) Organised exchanges
(b) Over-the-counter (OTC)
Four commodity exchanges are established in India to deal with

commodity trading as follows
Multi Commodity Exchange of India Ltd (MCX), located at Mumbai
National Commodity and Derivatives Exchange Ltd (NCDEX), located at

Mumbai
National Board of Trade (NBOT), located at Indore
National Multi Commodity Exchange (NMCE), located at Ahmedabad.
In OTC market trading directly happens between the contracting

counterparties over the telephone or through electronic media by a
collection of broker-dealers scattered across the country. The OTC
derivative markets have banks, financial institutions hedge funds,
corporations and high net-worth individuals as market participants. OTC
derivative market is less regulated market that organized exchange as OTC
transactions are done in private where as exchange transactions are
regulated by SEBI. The OTC Contracts are tailor made to fit in the specific
requirements of dealing counterparties where exchange contracts have
fixed specifications and standardised. OTC transactions credit risk is
managed within individual institutions where as exchange transactions
credit risk(settlement of transaction) is guaranteed by the Clearing
Corporation. The exchange transaction are prices determined by the
interaction of buyers and sellers through anonymous auction platform
where as OTC transaction price is decided between known parties.
! !343
8.4 Risks associated with Derivatives
Investors must understand that investment in derivatives has an element

of risk and is generally not an appropriate avenue for someone of limited
resources/ limited investment and/or trading experience and low risk
tolerance. An investor should select the derivative trading strategy based
on his risk appetite and risk tolerance level. Investors who trade in
derivatives at the Exchange should carefully read the Model Risk Disclosure
Document and the details contained therein provided by the broker and
fully understand the implications before investing in derivatives.
The primary risks associated with trading derivatives are market,

counterparty, liquidity and interconnection risks.
a. Credit risk: loss due to counterparty party failure to perform obligation
b. Market risk: Loss due to adverse changes in the market value
c. Liquidity risk: Failure of an institution to meet its funding requirement
d. Operational risk: Loss due to inadequate systems and control, human

error, management failure
e. Legal risk: Loss arising from legally non enforceable contracts
f. Regulatory risk: Loss arising from failure to comply with regulatory or

legal requirement
g. Reputation risk: Loss arising from adverse public opinion
h. Settlement Risk: Arises as a result of the timing differences between

when an institution either pays out funds or deliverables assets before
receiving assets or payments from a counterparty and it occurs at a
specific point in the life of the contract.
i. Strategic Risk: Arises from activities such as entrepreneurial behavior

of traders in financial institutions, misreading client requests, costs
getting out of control, trading with inappropriate counterparties etc
! !344
j. Systemic Risk: Arises when there is a failure of large and complex

organization of financial positions in the economy.
8.5 Commercial usage of derivatives
Globalization has caused larger inflow and out flow of money at greater risk
and hence derivative securities have acquire a magnanimous significance in
the modern economic environment. Commodity trading is no more
restricted to national boundaries. In fact innovative technology has created
rapid communications and transportations to seamlessly facilitate
transportation across the borders and augment the flow of credit for
international trade. This has enhanced volatility in commodity prices across
the globe, exposing the participants in commodities trading to considerable
risk.
Derivatives suit better in this growing market full of volatility in exchange

rates to manage the risk and fulfill the commercial obligations. Derivatives
are highly useful in mitigating the risk in trading and investment.
Derivatives markets help increase savings and investment in the long run.
Transfer of risk enables market participants to expand their volume of
activity.
Derivatives can provide various services and usage to the

commercial world namely:
Corporates: Companies use currency forwards and other derivatives to

hedge foreign exchange exposures. Commodity derivatives are used to
hedge raw material consumption. Interest rate derivatives to hedge
borrowing costs.
Mutual Funds: Use currency forwards and other derivatives to hedge

international asset and liability portfolio. Swaps and interest rate
derivatives to protect portfolios. Commodity futures to invest in asset
classes.
Financial Service Firms: Hedge inventory of securities. Banks act as

dealers in derivative markets and make profit on arbitrage
! !345
Individuals: Speculate on asset prices. To hedge non-tradable assets.

Derivative markets can also provide various benefits to traders as follows:
1. Derivatives market allows you to earn money without physical

settlement.
2. Derivative market enables arbitrage trading i.e. buy low in one market
and sell high in the other market. Investor can take advantage of
differences in prices in the two markets.
3. Derivative market offers hedging against a future fall in the price of the
underlying. It also offers products that protect you from a rise in the
price of shares that you plan to purchase.
4. The most important use of derivatives is the transfer of market risk from
risk-averse investors to those with an appetite for risk. Risk-averse
investors use derivatives to enhance safety.
8.6 Summary
Derivative is a product whose value is derived from the value of one or

more basic variable called the underlying e.g equity, forex, commodity or
any other asset. Derivative market in India is believed to be in existence
since the ancient times. The derivative market in India, is increasingly
gaining significance.
Derivatives are one of the three main categories of financial instruments,
the other two being stocks (i.e., equities or shares) and debt (i.e., bonds
and mortgages).
There are two types of Derivatives:
(a) Commodity Derivative

(b) Financial Derivative
A forward contract is a simple customized contract between two parties to

buy or sell an asset at a certain time in the future for a certain price.
A futures contract is an agreement between two parties to buy or sell an
asset at a specified time in the future for a specified price through an
exchange.
! !346
An Option contract is an agreement between two parties whereby one

party obtains the right, but not the obligation, to buy or sell a particular
asset, at a specified price, on or before a specified date. A call option gives
the holder the right to buy the underlying asset by a certain date for a
certain price. A put option gives the holder the right to sell the underlying
asset by a certain date for a certain price. Options strategies are formed by
combining any of the four basic kinds of option trades with different
exercise prices and maturities.
A currency future is also known as FX future, is a futures contract to

exchange one currency for another at a specified date in the future at a
price (exchange rate) that is fixed on the purchase date. Currency future
contracts allow investors to hedge against foreign exchange risk. An
investor that expects a currency to become strong will buy currency
futures. If the investor expects the currency to weaken will sell currency
futures.
Warrant is just like an option contract where the holder has the right to
buy shares of a specified company at a certain price during the given time
period.
Convertibles are hybrid instruments which gives a choice between bonds

and shares. They combine the basic attributes of fixed interest and variable
return securities.
Swaps are private agreements between two parties to exchange cash flows
in the future. The two commonly used swaps are: (a)interest rate swaps
and (b)currency swaps.
A stock index is an indicator of the performance of overall market. Index is

prepared by giving to each stock according to its market capitalization.
Non-standard derivatives were formed by combining two or more ‘plain
vanilla’ call and put options whereas some others were far more complex.
Examples of non-standard derivatives: forward start option, compound
options, choose options, barrier options, binary options, look back options,
shout options, Asian options, basket.
! !347
Derivatives markets are attracted by different types of traders namely:

(a) Hedgers
(b) Speculators (Margin traders, Day traders, Position traders)
(c) Arbitrageurs
Investors must understand that investment in derivatives has an element

of risk and is generally not an appropriate avenue for someone of limited
resources/ limited investment and / or trading experience and low risk
tolerance. An investor should select the derivative trading strategy based
on his risk appetite and risk tolerance level.
Derivatives suit better in this growing market full of volatility in exchange

rates to manage the risk and fulfill the commercial obligations. Derivatives
are highly useful in mitigating the risk in trading and investment.
Derivatives markets help increase savings and investment in the long run.
Transfer of risk enables market participants to expand their volume of
activity. Derivatives can provide various services and usage to the
commercial world.
1. Write a short note on evolution of Derivative market.
2. “The derivative market in India, is increasingly gaining significance”

Explain.
3. What is the difference between financial derivative and commodity

derivative?
4. What are the different types of financial derivatives?
5. What are the different types of commodity derivatives?
6. What is a forward contract? Explain the basic features of a forward

contract
7. How can a Forward contract be used in hedging and speculation?
! !348
8. What is a futures contract? Explain the basic features of a futures

contract.
9. Explain the applications of Futures in the commercial world.
10.What is the difference between Forward and Future contract?
11.What is a Option contract? Explain the basic features of a Options

contract.
12. What is a Call and a Put Option?
13.Describe the different Option Styles?
14.What is In the Money Option, Out of the Money Option and At the
Money Option?
15.Explain the various forms of Options Payoff matrix?
16.What are the various Option strategies?
17.What is the difference between Futures and Options?
18.What is a currency future? When will an investor buy or sell currency

futures?
19.What is the difference between a warrant and convertible?
20.What are swaps. What are the different types of swaps?
21.What are stock market indices?
22.What is an Exotic or Non-standard Derivative?
23.Explain the participants in the Derivatives Market.
24.Explain the Risks associated with Derivatives.
25.Explain the Commercial usage of derivatives.
! !349
1. Derivative market offers hedging against a future fall in the price of the
underlying. It also offers products that protect you from a rise in the
price of shares that you plan to purchase. State whether the above
(a) True
(b) False
2. Derivatives are one of the three main categories of financial

instruments, the other two being stocks (i.e., equities or shares) and
debt (i.e., bonds and mortgages). Which of the following is not a feature
of a forward contract?
(a) Forward contracts are bilateral contracts
(b) Forward contract is traded on exchanges
(c) Exposed to counter-party risk
(d) Each contract is custom designed
3. A currency swap is a foreign exchange derivative between two

institutions who agree to exchange both principal and interest payments
of loan in one currency for equivalent amount in net present value terms
in another currency. For which of the following purpose a currency swap
is used?
(a) To secure cheaper debt
(b) To hedge against forward exchange rate fluctuations
(c) To defend against financial turmoil due to liquidity crisis
(d) All of the above
4. Investors must understand that investment in derivatives has an

element of risk and is generally not an appropriate avenue for someone
of limited resources/ limited investment and / or trading experience and
low risk tolerance. Failure of an institution to meet its funding
requirement leads to which type of risk?
(a) Market risk
(b) Operational risk
(c) Liquidity risk
(d) Legal risk
! !350
5. Derivatives markets are of two types: (a) Organised exchanges and

(b) Over-the-counter (OTC). Derivatives trading can happen on either of
the market. Which of the following feature is not be considered as a feature
of an Over-the-counter market?
a. Trading directly happens between the contracting counterparties

b. Settlement of transaction is guaranteed by the Clearing Corporation
c. Less regulated market
d. Contracts are tailor made to fit in the specific requirements of dealing
counterparties
Ans: 1 - (a), 2 - (b),3 - (d), 4 - (c), 5 - (b)
8.8 References
1. Options Futures & Other Derivatives by John C Hull and Sankarshan

Basu
2. Derivatives and Risk Management by Rajiv Srivastava
3. Financial Derivatives: Theory, Concepts and Problems by S.L. Gupta
4. Fundamentals of Financial Instruments: An Introduction to Stocks,

Bonds, Foreign Exchange and Derivatives by Sunil Parameswaran
5. Commodity and Financial Derivatives by Kevin S
6. Derivatives Principles and Practice by Sundaram
7. Fundamentals of Financial Derivatives by N.R. Parasuraman
8. Derivatives by T. V. Somanathan and V. Anantha Nageswaran
9. Guide To Future & Options by Ankit Gala and Jitendra Gala
! !351
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !352
ALTERNATE FORMS OF INVESTMENTS
Chapter 9
Alternate Forms of Investments
Objectives:
This chapter will help you understand the Investment options available for
investing through the ADR and GDR route. It will also help you to
understand FCCB, FCEB a well as the AIF options of investing.
Structure:
9.1 Introduction
9.2 What is a Depository Receipt (DR)?
9.3 American Depositary Receipts (ADRs)
9.4 Global Depository Receipt (GDR)
9.5 Foreign Currency Convertible Bonds (FCCBs)
9.6 Foreign Currency Exchangeable Bonds (FCEB)
9.7 Alternate Investment Fund (AIF)
9.8 Summary
9.10 References
! !353
9.1 Introduction
Alternative investments are drawing high levels of interest in this

liberalized world with globalized markets without any boundaries. Investing
in global markets gives the biggest benefit of diversification and grabbing
of attractive opportunities. Investing in stocks of foreign companies can be
rewarding for investors who have patience to do their research on both
opportunities and risk and only then invest. An individual can collaborate
with brokers providing trading facilities of stocks in foreign countries by
fulfilling legal formalities and facing the currency exchange and trading
hour time difference. Similarly a registered broker in India can purchase
shares of an Indian company on behalf of a person resident outside India
for the purpose of converting the shares so purchased into ADRs
The Indian investor will be looking for a good rupee return by investing in a
global market. This rupee return will largely depend upon the change in the
exchange rate between the foreign currency and the Indian national
rupee(INR). The Indian investor investing in global markets can also use
the Capital Asset Pricing Model (CAPM) or the arbitrage pricing theory to
estimate expected returns in the global markets. Investors are provided
varied opportunities as bigger companies are getting listed in more than
one country. That’s not all we also hear the growing cross border mergers
and acquisitions happening quite often.
Investment options are available both in developed markets as well as in

emerging markets. One can buy stocks of domestic companies as well as
multinational companies of developed and emerging markets.
Investors can invest in multinational companies not head quartered in

United States of America through American Depository Receipts (ADRs).
These ADRs are listed on stock exchanges in US such as New York Stock
Exchange and Nasdaq,. ADRs are bought and sold in US dollars as if they
were ordinary shares of US based companies. Dividends are also paid in US
dollars. ADRs are to be registered with the Securities Exchange
Commission(SEC), US. Infosys was the first Indian company to be listed on
Nasdaq in the year 1999. U.S. stocks represent approximately 30% of the
total value of global markets.
! !354
If ADR is for diversification in equity, Yankee bonds can be used by bond

investors to diversify in global markets. Yankee bonds are dollar
denominated bonds issued by non-US companies as well as governments
in the US bond markets. Yankee bonds also needs to be registered with the
Securities Exchange Commission. Individual investors can make good
money by investing in countries having low price-earning ratio, low piece-
to-book value ratio, low political risk and high dividend yield.
Investors can easily get information not only about various companies on
internet and social media but they can easily determine a target
investment and monitor the return on investment seamlessly. Investing in
foreign companies can be profitable but the rewards come with additional
risks such as political, currency, liquidity, custody and market risk.
Individual investors may find it difficult to identify profit oriented stocks.
Those investors who do not find it easy or find it risky, can do foreign
investment through Mutual Funds. International mutual funds offer open
ended, closed ended as well as exchange traded funds.
The global investments can be tracked through every foreign countries

indices such as the Dow Jones Industrial Average of the US, Nikkei 225 of
Japan, FTSE of UK , DAX of Germany, BEL 20 of Belgium, Bovespa of
Brazil, S&PTSK of Canada, Shanghai of China, S&P ASX 200 of Australia,
CAC 40 of France, FTSE MIB of Italy, NZX 50 of New Zealand, MOEX of
Russia, STI of Singapore, KOSPI of South Korea, IBEX 35 of Spain, SMI of
Switzerland, OMX S30 of Sweden, ADX General of UAE, HNX 30 of Vietnam
etc. Since different countries will have their own ways to calculate and
construct indices comparisons on certain parameters may not give uniform
results However in such cases, investors can rely on independent indices
creators such as the Morgan Stanley Capital International (MSCI) who
compiles indices for individual countries, regions, developed markets,
emerging markets as well as the entire world.
By introducing financial sectors reforms in lines with the liberalization and

globalization concepts, government has also proactively taken various
policies initiatives to allow India companies to raise funds from foreign
markets. The notable introductions by the government were in the form of
FCCB and Ordinary Share (through Depository Receipt Mechanism) Scheme
1993, Foreign Currency Exchangeable Bonds Scheme 2008, the
Consolidated FDI Policy and Depository Receipts Scheme, 2014. The
Ministry of Corporate Affairs has notified Companies (Issue of Global
! !355
Depository Receipts) Rules, 2014 for Issue of GDR. The ultimate

beneficiary is the investors because based on his investment and risk
tolerance appetite, he now has new and modern types of instruments
namely American Depository Receipts (ADR), Global Depository Receipts
(GDR), Foreign Currency Convertible Bonds (FCCBs) and Foreign currency
Exchangeable Bonds (FCEBs) originated due to increase globalization.
The Euro issues enables Indian companies to raise funds outside India in
foreign currency. The two main types of Euro issues are Depository
Receipts for e.g. American Depository Receipts and Foreign Currency
Exchangeable Bonds for e.g. Global Depository Receipts (GDR). American
Depository Receipts are issued to existing share holders (sponsored ADRs)
or by way of issue of fresh shares. Global Depository Receipts can be
issued from Euro markets or US markets. The US portion of GDRs is to be
listed on US exchanges as per SEC requirements and the European portion
are to be listed on Euro exchanges as per EU directive.
9.2 What is a Depository Receipt (DR)?
A Depository Receipt (DR) is a negotiable instrument confirming ownership

of a fixed number of equity shares of the issuing Indian company,
denominated in foreign currency and traded in foreign exchanges. The
main aim of issuing Depository Receipts is to raise funds from global
markets, give an opportunity for the share holder to diversify his
investment in foreign markets and manage currency risk with simple
trading and settlement procedures.
Steps involved in issuing Depository Receipt
1. Indian Company issues rupee denominated Equity Shares to Domestic

Custodian
2. Domestic Custodian gives instructions to a foreign Depository to issue

Depository Receipts
3. Foreign Depository issues Depository Receipts to foreign investors
! !356
DRs are thus foreign currency denominated instruments issued by a foreign

Depository. Once the Depository Receipt is issued, the foreign investor can
start trading on foreign exchanges in the US, UK, Japan, Singapore,
Luxembourg, Hong Kong, Mexico, Germany, France, Brazil, China etc.
DRs may be issued in accordance with the Scheme for issue of Foreign
Currency Convertible Bonds and Ordinary Shares (Through Depository
Receipt Mechanism) Scheme, 1993 and DR Scheme 2014.
A sponsored issue of depository receipts is based on a stock agreement,

between the foreign depository and the issuer of securities. An
unsponsored issue of depository receipts does not involve any stock
agreement between the foreign depository and the issuer company.
DRs can be issued to person resident outside India under FEMA guidelines.
The aggregate of eligible securities issued or transferred to foreign
depositories, along with eligible securities held by persons resident outside
India, shall not exceed the limit on foreign holding of such eligible
securities under the relevant regulations framed under FEMA, 1999.
The issue of depository receipts should be reported to the Reserve Bank of

India by the domestic custodian.
9.3 American Depositary Receipts (ADRs)
American Depositary Receipts (ADRs) equity ownership in a non-US

company in dollars in the form of depository receipts. It represents a
specified number of foreign shares of the company which can be traded in
the U.S exchanges. The very reason of creating ADRs was to make it
simple and easy the trading of stock price of foreign companies in different
currencies and prices. Individuals benefit from ADRs as it is an easy and
cost-effective way to buy shares in a foreign company. It helps them to
reduce administrative cost and avoiding foreign taxes on each transaction.
Foreign companies also benefit from ADRs as it gives them an opportunity
to tap US markets.
! !357
ADRs can be classified into three levels
Level 1 ADRs can be unlisted, OTC traded/Pink Sheets. This is the least
expensive and lowest level to provide for issuance of shares in ADR. The
company issuing ADRs has to comply with the SEC registration
requirements. These ADRs can only be traded over-the counter and cannot
be listed.
Level 2 ADRs can be listed on US exchanges for Non-capital Raising

Transaction (i.e. without going for public issue) This approach gives more
liquidity and marketability to the issuing company. The company has to
comply with the registration requirements, reporting requirements of SEC.
Level 3 ADRs is the highest level a foreign company can sponsor and
such ADRs can be listed on US exchanges for Capital Raising Transaction
i.e., through fresh issue of shares. The company has to comply with
Registration, Reporting requirement and after document filing with SEC.
These company are subject to higher compliance and should adhere to U.S.
GAAP standards or IFRS.
A foreign company can enter into an agreement directly with the U.S.
depositary bank with sponsored ADRs. An Indian company may sponsor an
issue of ADR with an overseas depository against shares held by its
shareholders at a price to be determined by the Lead Manager.
An Indian company can sponsor an issue of ADR by offering its resident

shareholders a choice to submit their shares to the company for issuance
of ADRs. The proceeds of the ADR needs to be kept in Resident Foreign
Currency (Domestic) accounts in India.
An unsponsored ADR is promote by broker without the cooperation of the

foreign company.
US citizens can invest in stocks of foreign countries through American

Depository Receipts (ADR), and trade them on US bourses. US citizens
don’t have to worry much about foreign companies as these foreign
companies have to go through elaborate regulatory procedures before
listing which reduces the chances of fraud or incorrect representations by
companies. This gives a tremendous opportunity for foreign investor in
! !358
making simpler and flexible investments in foreign companies in

comparison to direct investment in a foreign market.
A limited two-way Fungibility scheme has been put in place by the

Government of India for ADRs which means a stock broker in India,
registered with SEBI, can purchase shares of an Indian company from the
market for conversion into ADRs. Re-issuance of ADRs is permitted to the
extent of ADRs which have been redeemed into underlying shares and sold
in the Indian market. Two way fungibility means shares issued in Indian
market can be reconverted by the issuing company into ADRs for purchase
by the overseas investors.
Indian companies are allowed to raise capital in the international market

through the issue of ADRs without obtaining prior approval from RBI in
terms of the Scheme for Issue of Foreign Currency Convertible Bonds and
Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993
and subsequent guidelines issued by Ministry of Finance, Government of
India. However after the issue of ADR, the Indian company has to file a
return with RBI in the proforma given in Annexure ‘C’ to the RBI
Notification No. FEMA.20/ 2000-RB dated May 3, 2000.
An extract of the above said Notification No. FEMA 20/2000-RB

dated 3rd May 2000 on ADR reads as follows
Issue of Shares by International offering through ADR and/or GDR
1. An Indian company may issue its Rupee denominated shares to a

person resident outside India being a depository for the purpose of
issuing Global Depository Receipts (GDRs) and/ or American Depository
Receipts (ADRs),
Provided the Indian company issuing such shares
a. has an approval from the Ministry of Finance, Government of India to

issue such ADRs and/or GDRs or is eligible to issue ADRs/GDRs in terms
of the relevant scheme in force or notification issued by the Ministry of
Finance, and
b. is not otherwise ineligible to issue shares to persons resident outside

India in terms of these Regulations, and
! !359
c. the ADRs/GDRs are issued in accordance with the Scheme for issue of
Foreign Currency Convertible Bonds and Ordinary Shares (Through
Depository Receipt Mechanism) Scheme, 1993 and guidelines issued by
the Central Government there under from time to time.
2. The Indian company issuing shares under sub-paragraph (1), shall

furnish to the Reserve Bank, full details of such issue in the form
specified in Annexure 'C', within 30 days from the date of closing of the
issue.
3. The Indian company issuing shares against ADRs/GDRs shall furnish a

quarterly return in the form specified in Annexure 'D' to Reserve Bank
within fifteen days of the close of the calendar quarter.
4. Pending repatriation or utilisation of foreign exchange resources raised

in terms of clause (1) the Indian company may invest the foreign
currency funds in -
a. deposits with or Certificate of Deposits or other instruments of banks

who have been rated not less than A1+ by Standard and Poor or P1
by Moody's for short term obligations,
b. deposits with branch outside India of an authorised dealer in India,

and
c. treasury bills and other monetary instruments with a maturity or un-

expired maturity of the instrument of one year or less.
The following is the list of top Indian ADRs For U.S. Investors
1. Infosys Limited
2. WIPRO Limited
3. TATA Motors Limited
4. ICICI Bank Limited
5. HDFC Bank Limited
! !360
9.4 Global Depository Receipt (GDR)
According to Section 2(44) of Companies Act, 2013, “Global Depository

Receipt” means any instrument in the form of a depository receipt, by
whatever name called, created by a foreign depository outside India and
authorized by a company making an issue of such depository receipts.
The Companies Act, 2013 has laid down provisions for issue of
Global Depository receipts under Section 41 and The Companies (Issue
of Global Depository Receipts) Rules, 2014. The issuing company can issue
depository receipts in any foreign country only after passing a special
resolution in its general meeting.
Steps for issue of GDRs
1. Indian company to issue rupee denominated shares to a Depository

outside India where the GDRs are proposed to be issued
2. Indian custodian to keep these securities in his custody
3. The investment banker would organize road shows for marketing the
issue
4. The foreign Depository would issue dollar denominated GDRs to foreign

investors
5. GDRs are listed in American and European Stock Exchanges
6. Indian company has to comply EU directives and SEC requirements
Rule 3 of Companies (Issue of Global Depository Receipts) Rules, 2014

states that a company may issue depository receipts provided it is
eligible to do so in terms of the Scheme and relevant provisions of the
Foreign Exchange Management Rules and Regulations.
! !361
Rule 4 provides for the following conditions to be fulfilled by a company

for issue of depository receipts:
1. The Board of Directors of the company intending to issue depository

receipts shall pass a resolution authorising the company to do so.
2. The company shall take prior approval of its shareholders by a special
resolution to be passed at a general meeting.
3. The depository receipts shall be issued by an overseas depository bank

appointed by the company and the underlying shares shall be kept in
the custody of a domestic custodian bank.
4. The company shall ensure that all the applicable provisions of the
Scheme and the rules or regulations or guidelines issued by the Reserve
Bank of India are complied with before and after the issue of depository
receipts.
5. The company shall appoint a merchant banker or a practising chartered

accountant or a practising cost accountant or a practising company
secretary to oversee all the compliances relating to issue of depository
receipts and the compliance report taken shall be placed at the meeting
of the Board of Directors of the company or of the committee of the
Board of directors authorised by the Board in this regard to be held
immediately after closure of all formalities of the issue of depository
receipts.
Rule 5 provides for the manner and form of issue of depository receipts:
1. The depository receipts can be issued by way of public offering or

private placement or in any other manner prevalent abroad and may be
listed or traded in an overseas listing or trading platform.
2. The depository receipts may be issued against issue of new shares or

may be sponsored against shares held by shareholders of the company
in accordance with such conditions as the Central Government or
Reserve Bank of India may prescribe or specify from time to time.
3. The underlying shares shall be allotted in the name of the overseas

depository bank and against such shares, the depository receipts shall
be issued by the overseas depository bank abroad.
! !362
Rule 6 provides for voting rights of depository receipts holder:
1. A holder of depository receipts may become a member of the company

and shall be entitled to vote as such only on conversion of the
depository receipts into underlying shares after following the procedure
provided in the Scheme and the provisions of this Act.
2. Until the conversion of depository receipts, the overseas depository shall

be entitled to vote on behalf of the holders of depository receipts in
accordance with the provisions of the agreement entered into between
the depository, holders of depository receipts and the company in this
regard.
Rule 7 provides for procedure for remittance of proceeds as follows:
The proceeds of issues of depository receipts shall either be remitted to a

bank account in India or deposited in an Indian bank operating abroad or
any foreign bank (which is a Scheduled Bank under the Reserve Bank of
India Act, 1934) having operations in India with an agreement that the
foreign bank having operations in India shall take responsibility for
furnishing all the information which may be required and in the event of a
sponsored issue of Depository Receipts, the proceeds of the sale shall be
credited to the respective bank account of the shareholders.
GDRs have access usually to Euro market and US market. The US portion
of GDRs to be listed on US exchanges to comply with SEC requirements
and the European portion are to be complied with EU directive. Listing of
GDR may take place in international stock exchanges such as London Stock
Exchange, New York Stock Exchange, American Stock Exchange, NASDAQ,
Luxemburg Stock Exchange, Shanghai Stock Exchange, Japan Exchange
Group, Hong Kong Stock Exchange, Korea Exchange, Australian Securities
Exchange etc.
! !363
Companies issue GDRs for the following reasons
• To get additional source of finance

• To make it more visible in global markets
• To enable foreign investors to contribute for the growth of the company
Investors benefit form issuance of GDR for the following reasons
• Get an opportunity in invest in foreign companies

• Can get securities of foreign companies in domestic market
• Gives opportunity to diversify investments
• Can avoid currency risk
• Can trade in foreign securities in domestic exchanges
9.5 Foreign Currency Convertible Bonds (FCCBs)
Foreign Currency Convertible Bond (FCCB) are issued by an Indian

company in foreign currency in accordance with the Foreign Currency
Convertible Bonds and ordinary shares (through depository receipt
mechanism) Scheme 1993 and subscribed by a non-resident entity in
foreign currency and convertible into ordinary shares of the issuing
company in any manner, either in whole, or in part.
FCCBs are unsecured, and carry a fixed rate of interest with an option for
conversion into a fixed number of equity shares of the issuer company.
Interest and redemption price is payable in dollars. The coupon rate on
FCCB is generally lower than pure debt instrument.
FCCB does not require any rating nor any securities.
25% of the FCCB proceeds can be used for general corporate restructuring.
FCCB helps the issuing company to control dilution of capital structure into
equity.
Investors can benefit out of conversion into equity and guaranteed return
in the form of coupon rate payments.
Investors can also benefit from lower tax liability and significant Yield to
maturity.
! !364
9.6 Foreign Currency Exchangeable Bonds (FCEB)
The Foreign Currency Exchangeable Bonds (FCEB) is used to raise funds

from the international markets against the security and exchange ability of
shares of an Indian company. Both the principal and the interest is payable
in foreign currency. Exchange happens either wholly or partly or on the
basis of any equity related warrants attached to debt instruments.
Issue of Foreign Currency Exchangeable Bonds(FCEB) are regulated by

Foreign Currency Exchangeable Bonds Scheme, 2008 issued by Ministry of
Finance, Department of Economic Affairs.
Foreign Currency Exchangeable Bonds (FCEB) scheme gives a fantastic

opportunity for Indian promoters to leverage its value in group companies
for issuing shares in exchange to raise money overseas to fund their new
projects and acquisitions.
The proceeds of FCEB may be invested by the issuing company overseas in

Joint Ventures or Wholly Owned Subsidiaries abroad.
The basic difference between an FCCB and FCEB is
In FCCB offering, the bonds convert into shares of the company that
issued the bonds
In FCEB offering, the bonds are convertible into shares not of the issuer
company, but that of another company forming part of its group.
! !365
9.7 Alternate Investment Fund (AIF)
Retail investors such as mutual funds and collective investment schemes

are well regulated. Inoder to regulate Venture Capitalists, SEBI had notified
SEBI (Venture Capital Funds) Regulations, 1996 to encourage investments
into start-ups and mid-size companies.
SEBI has now notified the Alternative Investment Fund (AIF) Regulations,
2012 to govern unregulated entities involved in raising of private capital
from institutional investors or high net worth investors (“HNI”) with a view
to invest such funds in cross border opportunities. This Regulation has
replaced the existing SEBI (Venture Capital Funds) Regulations, 1996. All
Alternative Investment Fund are required to be registered with the SEBI.
All allowed Venture Capitalists are also required to register with SEBI under
the AIF Regulations before floating any new scheme.
Alternate Investment Fund (AIF) means any fund established in India

in the form of a trust, company, limited liability partnership or a body
corporate which:-
1. is a privately pooled investment vehicle that collects funds from

investors, whether Indian or foreign, for investing it in accordance with
a defined investment policy for the benefit of its investors; and
2. is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI
(Collective Investment Schemes)
Regulations, 1999 or any other regulations of SEBI, which aims to regulate

fund management activities.
The following entities shall not be considered as Alternative

Investment Fund for the purpose of these regulations,-
1. family trusts set up for the benefit of ‗relatives‘ as defined under

Companies Act, 2013
2. ESOP Trusts set up under the Securities and Exchange Board of India
(Employee Stock Option Scheme and Employee Stock Purchase
Scheme), Guidelines, 1999 or as permitted under Companies Act, 2013
! !366
3. employee welfare trusts or gratuity trusts set up for the benefit of

employees;
4. holding companies as defined in the Companies Act, 2013
5. other special purpose vehicles not established by fund managers,

including securitization trusts, regulated under a specific regulatory
framework; (vi) funds managed by securitisation company or
reconstruction company which is registered with the Reserve Bank of
India under Section 3 of the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002; and
6. any such pool of funds which is directly regulated by any other regulator
in India;
SEBI has classified AIF into the following three broad categories
Category I: Fund that invest in start-up or early stage ventures or social

ventures or Small and Medium Enterprises (SMEs) or infrastructure or
other sectors which the government or regulators consider as socially or
economically desirable which include VCF, SME Funds, Social Venture Funds
(SVF), Infra Funds and such other AIFs as may be specified in the AIF
Regulations.
Category II: Funds that do not fall in Category I and III AIF and those
that do not undertake leverage or borrowing other than to meet the
permitted day to day operational requirement. Alternative Investment
Funds such as private equity funds or debt funds for which no specific
incentives or concessions are given by the government or any other
Regulator shall be included.
Category III: Funds that employ diverse or complex trading strategies

and may employ leverage including through investment in listed or unlisted
derivatives. Alternative Investment Funds such as hedge funds or funds
which trade with a view to make short term returns or such other funds
which are open ended and for which no specific incentives or concessions
are given by the government or any other Regulator shall be included.
Category - III Alternative Investment Funds (AIFs) can also participate in
the comodity derivatives market.
! !367
All Alternative Investment Funds shall state investment strategy,

investment purpose and its investment methodology in its placement
memorandum to the investors.
Alternative Investment Fund may raise funds from any investor whether
Indian, foreign or nonresident Indians by way of issue of units. Each
scheme of the Alternative Investment Fund shall have corpus of atleast
twenty crore rupees. Alternative Investment Fund shall not accept from an
investor, an investment of value less than one crore rupees. Manager or
Sponsor shall have a continuing interest in the Alternative Investment Fund
of not less than two and half percent of the corpus or 5 crore rupees,
whichever is lower, in the form of investment in the Alternative Investment
Fund. No scheme of the Alternative Investment Fund shall have more than
1000 investors. The fund shall not solicit or collect funds except by way of
private placement.
Category I Alternative Investment Fund and Category II Alternative

Investment Fund shall be close ended. Category I and II Alternative
Investment Fund or schemes launched by such funds shall have a
minimum tenure of three years. Category III Alternative Investment Fund
may be open ended or close ended. Units of close ended Alternative
Investment Fund may be listed on stock exchange subject to a minimum
tradable lot of one crore rupees.
Alternative Investment Fund may invest in securities of companies

incorporated outside India subject to such conditions or guidelines that
may be stipulated or issued by the Reserve Bank of India and SEBI from
time to time. Reserve Bank of India (RBI) has permitted an Alternative
Investment Fund (AIF), registered with SEBI, to invest overseas in terms of
the provisions issued by RBI AIFs may invest in equity and equity linked
instruments only of offshore venture capital undertakings, subject to prior
approval for investment from SEBI. Investments would be made only in
those companies which have some form of work done in an India. These
investments would be subject to Foreign Exchange Management (Transfer
or Issue of Any Foreign Security) Regulations, 2004 and other guidelines
specified by RBI from time to time with respect to any structure which
involves Foreign Direct Investment (FDI) under Overseas Direct
Investment (ODI) route.
! !368
Category I and II Alternative Investment Funds shall invest not more than
twenty five percent of the investible funds in one Investee Company.
Category III Alternative Investment Fund shall invest not more than ten
percent of the investible funds in one Investee Company. Alternative
Investment Fund may act as Nominated Investor as specified in SEBI
(ICDR) Regulations, 2009.
All Alternative Investment Funds shall review policies and procedures, and
their implementation, on a regular basis, or as a result of business
developments, to ensure their continued appropriateness.
A Category III The Sponsor of Alternative Investment Fund shall appoint a

custodian registered with SEBI for safekeeping of securities. Category I and
II also are required to appoint a custodian registered with SEBI for
safekeeping of securities if the corpus of the Alternative Investment Fund is
more than 500 crore rupees.
Category I Alternative Investment Fund shall invest in investee

companies or venture capital undertaking or in special purpose vehicles or
in limited liability partnerships or in units of other Alternative Investment
Funds as specified in these regulations. Category I Alternative Investment
Funds shall not borrow funds directly or indirectly or engage in any
leverage except for meeting temporary funding requirements for not more
than thirty days, on not more than four occasions in a year and not more
than ten percent of the corpus.
Category II Alternative Investment Funds shall invest primarily in

unlisted investee companies or in units of other Alternative Investment
Funds as may be specified in the placement memorandum. Category II
Alternative Investment Funds may not borrow funds directly or indirectly
and shall not engage in leverage except for meeting temporary funding
requirements for not more than thirty days, not more than four occasions
in a year and not more than ten percent of the corpus. Category II
Alternative Investment Funds may enter into an agreement with merchant
banker to subscribe to the unsubscribed portion of the issue or to receive
or deliver securities in the process of market making under Chapter XB of
the Securities and Exchange Board of India (Issue of Capital and Disclosure
Requirements) Regulations, 2009.
! !369
Category II Alternative Investment Funds shall be exempt from regulation

3 and 3A of Securities and Exchange Board of India (Prohibition of Insider
Trading) Regulations, 1992 in respect of investment in companies listed on
SME Exchange or SME segment of an exchange pursuant to due diligence
of such companies subject to the following conditions:
a. the fund shall disclose any acquisition or dealing in securities pursuant

to such duediligence, within two working days of such acquisition or
dealing, to the stock exchanges where the investee company is listed;
b. such investment shall be locked in for a period of one year from the
date of investment
Category III Alternative Investment Funds may invest in securities of

listed or unlisted investee companies or derivatives or complex or
structured products. Category III Alternative Investment Funds may
engage in leverage or borrow subject to consent from the investors in the
fund and subject to a maximum limit, as may be specified by SEBI.
The Sponsor and Manager of the Alternative Investment Fund shall act in a
fiduciary capacity towards its investors and shall disclose to the investors,
all conflicts of interests as and when they arise or seem likely to arise.
All Alternative Investment Funds shall ensure transparency and disclosure

of information to investors on the following:
a. financial, risk management, operational, portfolio, and transactional

information regarding fund investments shall be disclosed periodically to
the investors;
b. any fees ascribed to the Manager or Sponsor; and any fees charged to
the Alternative Investment Fund or any investee company by an
associate of the Manager or Sponsor shall be disclosed periodically to
the investors;
c. any inquiries/ legal actions by legal or regulatory bodies in any

jurisdiction, as and when occurred;
d. any material liability arising during the Alternative Investment Fund‘s

tenure shall be disclosed, as and when occurred;
! !370
e. any breach of a provision of the placement memorandum or agreement

made with the investor or any other fund documents, if any, as and
when occurred;
f. change in control of the Sponsor or Manager or Investee Company.
g. Alternative Investment Fund shall provide at least on an annual basis,

within 180 days from the year end, reports to investors including the
following information, as may be applicable to the Alternative
Investment Fund:
(A) financial information of investee companies.
(B) material risks and how they are managed which may include:
i. concentration risk at fund level;

ii. foreign exchange risk at fund level;
iii. leverage risk at fund and investee company levels;
iv. realization risk (i.e. change in exit environment) at fund and investee
company levels;
v. strategy risk (i.e. change in or divergence from business strategy) at
investee company level;
vi. reputation risk at investee company level;
vii.extra-financial risks, including environmental, social and corporate
governance risks, at fund and investee company level.
The Alternative Investment Fund shall provide to its investors, a

description of its valuation procedure and of the methodology for valuing
assets. Category I and Category II Alternative Investment Funds shall
undertake valuation of their investments, at least once in every six
months, by an independent valuer appointed by the Alternative Investment
Fund. Category III Alternative Investment Funds shall ensure that
calculation of the net asset value (NAV) is independent from the fund
management function of the Alternative Investment Fund and such NAV
shall be disclosed to the investors at intervals not longer than a quarter for
close ended Funds and at intervals not longer than a month for open ended
funds.
! !371
An Alternative Investment Fund, by itself or through the Manager or

Sponsor, shall lay down procedure for resolution of disputes between the
investors, Alternative Investment Fund, Manager or Sponsor through
arbitration or any such mechanism as mutually decided between the
investors and the Alternative Investment Fund.
9.8 Summary
Alternative investments are drawing high levels of interest in this

liberalized world with globalized markets without any boundaries. Investing
in global markets gives the biggest benefit of diversification and grabbing
of attractive opportunities.
A Depository Receipt (DR) is a negotiable instrument confirming ownership

of a fixed number of equity shares of the issuing Indian company ,
denominated in foreign currency and traded in foreign exchanges. The
main aim of issuing Depository Receipts is to raise funds from global
markets, give an opportunity for the share holder to diversify his
investment in foreign markets and manage currency risk with simple
trading and settlement procedures. DRs can be issued to person resident
outside India under FEMA guidelines.
American Depositary Receipts (ADRs) equity ownership in a non-US

specified number of foreign shares of the company which can be traded in
the U.S exchanges.
According to Section 2(44) of Companies Act, 2013, “Global Depository

Receipt” means any instrument in the form of a depository receipt, by
whatever name called, created by a foreign depository outside India and
authorized by a company making an issue of such depository receipts.
Foreign Currency Convertible Bond (FCCB) are issued by an Indian

company in foreign currency in accordance with the Foreign Currency
Convertible Bonds and ordinary shares (through depository receipt
mechanism) Scheme 1993 and subscribed by a non-resident entity in
foreign currency and convertible into ordinary shares of the issuing
company in any manner, either in whole, or in part.
! !372
The Foreign Currency Exchangeable Bonds (FCEB) is used to raise funds

from the international markets against the security and exchangeability of
shares of an Indian company. Both the principal and the interest is payable
in foreign currency. Exchange happens either wholly or partly or on the
basis of any equity related warrants attached to debt instruments.
Alternate Investment Fund (AIF) means any fund established in India in

the form of a trust, company, limited liability partnership or a body
corporate which:-
a. is a privately pooled investment vehicle that collects funds from

investors, whether Indian or foreign, for investing it in accordance with
a defined investment policy for the benefit of its investors; and
b. is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI
(Collective Investment Schemes)Regulations, 1999 or any other
regulations of SEBI, which aims to regulate fund management activities.
! !373
1. What is a Depository Receipt (DR)? What are the steps involved in

issuing Depository Receipt?
2. What is an American Depositary Receipt? What are the different types of

American Depositary Receipt?
3. What is a two-way Fungibility scheme?
4. Make a list of top Indian ADRs For U.S. Investors.
5. What is a Global Depository Receipt?
6. Explain the provisions of Global Depository Receipt made Companies

Act, 2013.
7. What are steps for issue of GDRs?
8. What are the advantages of issue of GDRs to companies issuing GDRs.
9. How can a investor benefit from issuance of GDR?
10.What is a Foreign Currency Convertible Bond (FCCB)?
11.What is a Foreign Currency Exchangeable Bonds (FCEB)?
12.What is the basic difference between an FCCB and FCEB?
13.What is a Alternate Investment Fund (AIF)?
14.Which entities shall not be considered as Alternative Investment Fund?
15.SEBI has classified AIF into the how many broad categories. Explain.
! !374
1. If ADR is for diversification in equity, Yankee bonds can be used by bond

investors to diversify in global markets. Yankee bonds are dollar
denominated bonds issued by non-US companies as well as
governments in the US bond markets. State whether the above
(a) True
(b) False
2. American Depositary Receipts (ADRs) equity ownership in a non-US

specified number of foreign shares of the company which can be traded
in the U.S exchanges. Which of the following ADRs are considered of the
highest level?
(a) Level 1
(b) Level 2
(c) Level 3
(d) Level 9
3. An Indian company may issue its Rupee denominated shares to a

person resident outside India being a depository for the purpose of
issuing Global Depository Receipts (GDRs) and/ or American Depository
Receipts (ADRs). Which of the following companies first issued the ADR?
(a) Infosys
(b) Wipro
(c) Reliance
(d) ICICI Bank
4. GDRs have access usually to Euro market and US market. The US

portion of GDRs to be listed on US exchanges to comply with SEC
requirements and the European portion are to be complied with EU
directive. Companies issue GDR for which of the following reasons?
(a) To get additional source of finance
(b) To make it more visible in global markets
(c) To enable foreign investors to contribute for the growth of the
company
! !375
5. Alternative Investment Fund may raise funds from any investor whether
Indian, foreign or nonresident Indians by way of issue of units. Each
scheme of the Alternative Investment Fund shall have corpus of atleast:
(a) Two crore rupees
(b) Twenty crore rupees
(c) Two hundred crore rupees
(d) Two thousand crore rupees
Ans: 1 - (a), 2 - (c), 3 - (a), 4 - (d), 5 - (b)
! !376
9.10 References
1. Foreign Banking and Investment in the United States: Issues and

Alternatives by Francis A. Lees
2. The Investor's Guidebook to Alternative Investments: The Role of

Alternative Investments in Portfolio Design by Stuart R. Veale
3. The Little Book of Alternative Investments: Reaping Rewards by daring

to be Different by Ben Stein and Phill Demuth
4. The Handbook of Professionally Managed Assets: A Definitive Guide to

Profiting from Alternative Investments by Keith R. Fevurly
5. Alternative Investments: A Primer for Investment Professionals by

Donald R. Chambers and Keith H. Black
6. The Handbook of Traditional and Alternative Investment Vehicles:

Investment Characteristics and Strategies by Mark J. P. Anson and Frank
J. Fabozzi
7. The Principles of Alternative Investments Management: A Study of the

Global Market by Ewelina Sokołowska
8. American Depository Receipts: Handbook by Richard J. Coyle
9. Passport to Profits: Why the Next Investment Windfalls Will be Found

Abroad and How to Grab Your Share by Mark Mobius
10.International Investing with ADRs: Your Passport to Profits Worldwide

by Eric J Fry
11.Integrating Europe's Financial Markets by by Jörg Decressin, Wim

Fonteyne & Hamid Faruqee
12.Companies Act, 2013
! !377
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !378
INVESTMENT IN FOREIGN COMPANIES
Chapter 10
Investment in Foreign Companies
Objectives:
This chapter will help you understand the Investment options available for
Indians to invest in foreign companies within the realms of the Companies
Act 2013, ICDR regulations and SEBI and Reserve Bank of India provisions.
Structure:
10.1 Introduction
10.2 What Exactly is an Indian Depository Receipt?
10.3 Benefits of Indian Depository Receipt to Issuing foreign company and

Indian Investors
10.4 Summary
10.6 References
! !379
10.1 Introduction
Like we saw in the previous chapter Alternative investments are drawing

high levels of interest in this liberalized world with globalized markets
without any boundaries. It has not only enabled foreign investors to invest
in Indian companies but has also enabled Indian investors to invest in
foreign companies. Indian investors can invest in foreign companies means
a foreign company can raise money in India for its overseas projects and
expansion. Such foreign company may not go through the listing process in
India but wish to share the risk and rewards of the issue with Indian
shareholders. The process is similar to an ADR or GDR except one
difference here i.e. Indian investor can buy ownership in a foreign
company. This process is similar to the initial public offering where a draft
prospectus is filed with the Securities and Exchange Board of India. The
entire process which are trying to talk about is issue of an Indian
Depository Receipts to an Indian investor for investing in a foreign
company.
Indian Depository Receipt (IDR) is a form of a depository receipt

denominated in Indian Rupees. IDR's are based on the original American
depositary receipts concept that were first introduced in 1927 in the US. A
foreign company can access Indian securities market for raising funds
through issue of Indian Depository Receipts (IDRs). Indian Depository
Receipt. IDRs are transferable securities listed on Indian stock exchanges
in the form of depository receipt.
Standard Chartered plc was the first foreign company to Indian Depository
Receipts in 2010. The IDRs were listed at the Bombay Stock Exchange as
well the National Stock Exchange.
Under the Liberalized Remittance Scheme of RBI Reserve Bank of India,

resident individuals are permitted to remit a maximum of USD 250,000 per
financial year for any permitted capital and current account transactions or
a combination of both, including the purchase of immoveable property or
shares or any other asset outside India without prior approval of the RBI.
Indian resident individuals can also acquire foreign securities, through

funds paid out of a resident foreign currency account.
! !380
Indian entities are permitted to make overseas direct investments by

making investments in securities of companies in overseas jurisdictions per
the provisions of the Foreign Exchange Management (Transfer or Issue of
any Foreign Security) Regulations, 2004.
IDRs offer Indian residents which includes both individuals and corporate
entities to freely invest in foreign companies.
10.2 What exactly is an Indian Depository Receipt?
Indian Depository Receipts (IDRs) enables an Indian investor to invest in

foreign equity. IDRs enables a foreign companies to raise capital in India
with prior permission of SEBI. IDRs are to be listed and denominated in
Indian Currency. Indian Depository Receipt means is in the form of a
depository receipt created by Domestic Depository in India against the
underlying equity shares of foreign issuing company.
IDR is thus a gift of technology breaking barriers to raise capital for a

company from domestic source only. Governments proactive policies to
attract foreign companies to invest in India has created IDR as a special
opportunity to not only the foreign companies to raise capital in India, but
also for the Indian investors who want to diversify their investments by
investing in foreign companies.
The regulatory bodies involves in issue of IDR are:
• The Ministry of Corporate Affairs

• The Securities and Exchange Board of India
• The Reserve Bank of India
According to section 2(48) of the Companies Act, 2013 “Indian

Depository Receipt” means any instrument in the form of a depository
receipt created by a domestic depository in India and authorised by a
company incorporated outside India making an issue of such depository
receipts.
Section 390 of the Companies Act, 2013 and rule 13 of Companies

(Registration of Foreign Companies) Rules, 2014 lays down the procedure
for issue of Indian Depository Receipts.
! !381
Rule 13 of Companies (Registration of Foreign Companies) Rules,

2014 are applicable to companies incorporated outside India and they
have or have not, or will or will not, establish any place of business in
India.
Section 390 of the Companies Act, 2013 states that the Central
Government may make rules applicable for:
• the offer of Indian Depository Receipts
• the requirement of disclosures in prospectus or letter of offer issued in

connection with Indian Depository Receipts;
• the manner in which the Indian Depository Receipts shall be dealt with in
a depository mode and by custodian and underwriters; and
• the manner of sale, transfer or transmission of Indian Depository

Receipts, by a company incorporated or to be incorporated outside India,
whether the company has or has not established, or will or will not
establish, any place of business in India.
The issuing company also has to comply with Chapter X and XA of SEBI
(ICDR) Regulations, 2009 to issue IDRs or a rights issue of IDRs.
Thus IDR means: any instrument in the form of a depository receipt

created by a domestic depository in India
Such issuance is authorized by a company incorporated outside India
An issuing company making an issue of IDR:
• Should have been listed in its home country
• Is not prohibited to issue securities by any regulatory body
• Has track record of compliance with securities market regulations in its

home country
! !382
Eligibility for issue of IDR: as per sub rule 2 of Rule 13 Companies

(Registration of Foreign Companies) Rules, 2014
a. its pre-issue paid-up capital and free reserves are at least US$ 50
million and it has a minimum average market capitalization (during the
last three years) in its parent country of at least US$ 100 million;
b. it has been continuously trading on a stock exchange in its parent or

home country (the country of incorporation of such company) for at
least three immediately preceding years;
c. it has a track record of distributable profits in terms of section 123 of

the Act, for at least three out of immediately preceding five years;
d. it fulfills such other eligibility criteria as may be laid down by the SEBI
from time to time in this behalf
Conditions for issue of IDR:
• Issue size shall not be less than fifty crore rupees
• Procedure to be followed by each class of applicant for applying shall be

mentioned in the prospectus
• Minimum application amount shall be twenty thousand rupees
• At least fifty per cent. of the IDR issued shall be allotted to qualified
institutional buyers on proportionate basis
• The balance fifty per cent. may be allocated among the categories of
non-institutional investors and retail individual investors
• At any given time, there shall be only one denomination of IDR of the
issuing company
• The Indian depository Receipts shall not be automatically fungible into

underlying equity shares of issuing company
• For non-underwritten issues If the issuing company does not receive the
minimum subscription of ninety per cent of the offer through offer
! !383
document on the date of closure of the issue, or if the subscription level

falls below ninety per cent. after the closure of issue on account of
cheques having being returned unpaid or withdrawal of applications, the
issuing company shall forthwith refund the entire subscription amount
received. If the issuing company fails to refund the entire subscription
amount within fifteen days from the date of the closure of the issue, it is
liable to pay the amount with interest to the subscribers at the rate of
fifteen per cent. per annum for the period of delay.
• For underwritten issues: If the issuing company does not receive the
minimum subscription of ninety per cent. of the offer through offer
document including devolvement of underwriters within sixty days from
the date of closure of the issue, the issuing company shall forthwith
refund the entire subscription amount received with interest to the
subscribers at the rate of fifteen per cent. per annum for the period of
delay beyond sixty days.
• The prospectus shall contain all material disclosures which are true,
correct and adequate so as to enable the applicants to take an informed
investment decision.
• In case of undersubscribed issue of IDR, the merchant banker shall

furnish information in respect of underwriters who have failed to meet
their underwriting devolvement to SEBI
• The executive director or managing director of the stock exchange,

where the IDR are proposed to be listed, along with the post issue lead
merchant bankers and registrars to the issue shall ensure that the basis
of allotment is finalised in a fair and proper manner in accordance with
the allotment procedure specified by SEBI.
! !384
Procedure for issuance of IDR: as per sub rule 2 of Rule 13

Companies (Registration of Foreign Companies) Rules, 2014
a. the issuing company shall, where required, obtain the necessary

approvals or exemptions from the appropriate authorities from the
country of its incorporation under the relevant laws relating to issue of
capital and IDRs.
b. issuing company shall obtain prior written approval from SEBI on an

application made in this behalf for issue of IDRs along with the issue
size
c. an application under clause (b) shall be made to SEBI (along with draft
prospectus) at least ninety days prior to the opening date of the IDRs
issue, in such form, along with such fee and furnishing such information
as may be specified by the SEBI from time to time. the issuing company
shall also file with SEBI, through a Merchant Banker, a due diligence
report along with the application under clause (b) in the form specified
by SEBI.
d. SEBI may, within a period of thirty days of receipt of an application

under clause (c), call for such further information, and explanations, as
it may deem necessary, for disposal of such application and shall
dispose the application within a period of thirty days of receipt of further
information or explanation. if within a period of sixty days from the date
of submission of application or draft prospectus, SEBI specifies any
changes to be made in the draft prospectus, the prospectus shall not be
filed with SEBI or Registrar of Companies unless such changes have
been incorporated therein.
e. the issuing company shall on approval being granted by the SEBI to an

application under clause (b), pay to the SEBI an issue fee as may be
prescribed from time to time by the SEBI.
f. the issuing company shall file a prospectus, certified by two authorized

signatories of the issuing company, one of whom shall be a whole-time
director and other the Chief Financial Officer, stating the particulars of
the resolution of the Board by which it was approved with SEBI and
Registrar of Companies, New Delhi before such issue. At the time of
filing of said prospectus with the Registrar of Companies, New Delhi, a
! !385
copy of approval granted by SEBI and the statement of fees paid by the
Issuing Company to SEBI shall also be attached.
g. the prospectus to be filed with SEBI and the Registrar of Companies,

New Delhi shall contain the particulars as prescribed in sub-rule (8) and
shall be signed by all the whole-time directors of the issuing company,
and the Chief Financial Officer.
h. the issuing company shall appoint an overseas custodian bank, a

Domestic Depository and a Merchant Banker for the purpose of issue of
IDRs.
i. the issuing company may appoint underwriters registered with SEBI to

underwrite the issue of IDRs the issuing company shall deliver the
underlying equity shares or cause them to be delivered to an Overseas
Custodian Bank and the said bank shall authorize the domestic
depository to issue IDRs.
j. the issuing company shall obtain in-principle listing permission from one
or more stock exchanges having nationwide trading terminals in India.
Steps involved in issuing Depository Receipt
1. Issuing Foreign company i.e incorporated outside India delivers equity

shares to foreign Custodian
2. Foreign custodian gives instructions to Indian Depository to issue

depository receipts in respect of shares held
3. Indian Depository issues depository receipts to Indians against the

equity shares of the company incorporated outside India
Once the IDR is issued to Indian investor, it can be traded in Indian stock
exchanges.
A holder of IDRs may transfer the IDRs by instructing the Domestic

Depository to redeem them or any person may seek reissuance of IDRs by
conversion of underlying equity shares, subject to the provisions of the
Foreign Exchange Management Act, 1999, the SEBI Act, 1992, or the rules,
! !386
regulations or guidelines issued under these Acts, or any other law for the
time being in force.
In case of redemption, Domestic Depository shall request the Overseas

Custodian Bank to get the corresponding underlying equity shares released
in favour of the holder of IDRs.
A holder of IDRs can also nominate a person of his choice to whom his
IDRs shall vest in the event of his death.
The repatriation of the proceeds of issue of IDRs shall be based on laws

relating to export of foreign exchange.
10.3 Benefits of Indian Depository Receipt to Issuing

foreign company and Indian Investors
India being one of the largest growing economy in the world and pro FDI
policies by the government is becoming increasingly popular for foreign
direct investments as well as raising of capital from Indian investors.
Many foreign companies are seeking to gain a foothold in sectors such as

Software technology, business process outsourcing, pharmaceuticals,
jewelry designing in which India has claimed leadership.
Benefits of IDRs for issuing companies
• India has an excellent stock market base as its exchanges are over 100
years old. Foreign Issuing Company gets access to well established,
monitored and regulated stock exchanges that are also compliant with
international standards for corporate governance
• In addition to well established stock exchanges Foreign Issuing Company

can also get excellent support from market intermediaries such as stock
brokers, custodians, depositories, clearing houses, Registrar and Transfer
Agents etc.
• Foreign Issuing Company will have to incur relatively low expenditure

and administrative cost in comparison to other major global stock
exchanges for listing securities in Indian stock markets
! !387
• India has the largest younger and middle class earning investor base in
the world. This provides a large pool of capital to the issuing company
• India has a good household savings rate which can attracted towards
equity
• Issuing company can increase its visibility in Indian markets and create
their brand value for their company as well as products
• Foreign companies can target established companies by acquiring them

through suitable share swap
• Existing shareholders of Issuing Company can seek an exit by tendering

their shares as underlying equity shares for issuance of IDRs
• Foreign Issuing Company can expand its investor base, with the help of
IDR offerings
• Issuing Company is not under any obligation to provide assured returns

on IDRs like in the case of debt instruments
Benefits of IDRs for Investors
• Indian investors can avoid hassle and higher legal compliances required
for direct investment in foreign equity
• The IDR route for investing in foreign companies provides better

investment portfolio diversification
• Indian investor can invest in IDR without requirement of brokerage

accounts in foreign countries and remitting money to foreign countries by
bearing exchange conversion cost. IDR permits issuance in Indian
currency
• The need for knowledge of the prevalent and necessary procedures

relating to trade, clearance and settlement in the country of foreign
issuing company is not required. This gives a big relief for Indian investor
who can invest in iDR with great ease.
! !388
• IDRs are traded on Indian stock exchange, hence Indian investor can
easily track his investment on a daily basis.
• Since the Foreign issuing company is required to execute a listing

agreement with Indian stock exchanges, they are bound to fulfil the SEBI
regulations, which in turn protects the interest of the Indian investors.
• Due to certain rights given by SEBI, Indian investors can easily claim
their rights relating to the IDR issuance
• IDRs gives Indian residents the chance to invest in an Indian listed

foreign entity within the limits specified in foreign exchange regulations
• If an Indian investor is also holding the underlying equity along with the
corresponding IDR, he can also take advantage of any arbitrage
opportunity due to any unsynchronized price fluctuations
• As the Indian Government has taken steps to liberalize India’s corporate

and securities laws to permit foreign companies to raise capital in India
and is continuing its pro-activeness, Indian investor can find multiple
opportunities in the near future to invest in foreign companies.
• The Foreign Issuing Company can also issue IDRs to non-residents after
seeking prior approval from RBI
• Employees of the Issuing Company are covered under the category of

retail investors and are eligible to subscribe to IDRs.
! !389
10.4 Summary
Indian Depository Receipt (IDR) is a form of a depository receipt

denominated in Indian Rupees. IDR's are based on the original American
depositary receipts concept that were first introduced in 1927 in the US. A
foreign company can access Indian securities market for raising funds
through issue of Indian Depository Receipts (IDRs). Indian Depository
Receipt. IDRs are transferable securities listed on Indian stock exchanges
in the form of depository receipt.
Standard Chartered plc was the first foreign company to Indian Depository
Receipts in 2010. The IDRs were listed at the Bombay Stock Exchange as
well the National Stock Exchange.
Under the Liberalized Remittance Scheme of RBI Reserve Bank of India,

resident individuals are permitted to remit a maximum of USD 250,000 per
financial year for any permitted capital and current account transactions or
a combination of both, including the purchase of immoveable property or
shares or any other asset outside India without prior approval of the RBI.
Indian resident individuals can also acquire foreign securities, through

funds paid out of a resident foreign currency account.
Indian entities are permitted to make overseas direct investments by

making investments in securities of companies in overseas jurisdictions per
the provisions of the Foreign Exchange Management (Transfer or Issue of
any Foreign Security) Regulations, 2004.
IDRs offer Indian residents which includes both individuals and corporate
entities to freely invest in foreign companies.
! !390
1. What is a Indian Depository Receipt (IDR)?
2. What are the steps for issuance of Indian Depository Receipt (IDR)?
3. How is Indian Depository Receipt (IDR) different from American

Depositary Receipt?
4. Who are the regulatory bodies involves in issue of IDR?
5. Explain the provisions of Section 390 of the Companies Act, 2013

relating to the powers of Central Government to make rules relating to
IDRs.
6. What is the eligibility for issue of IDR?
7. What are the conditions for issue of IDR?
8. What is the procedure for issuance of IDR?
9. What are the benefits of Indian Depository Receipt to Issuing foreign

company?
10.What are the benefits of Indian Depository Receipt to Indian Investors?
! !391
1. Indian Depository Receipts (IDRs) enables an Indian investor to invest

in foreign equity. IDRs enables a foreign companies to raise capital in
India with prior permission of SEBI. IDRs are to be listed and
denominated in
(a) US dollars
(b) Euro
(c) Indian currency
(d) Currency of Foreign issuing company
2. At least fifty per cent. of the IDR issued shall be allotted to qualified
institutional buyers on proportionate basis. The balance fifty percent.
may be allocated among the categories of non-institutional investors
and retail individual investors. Minimum application amount shall be:
(a) Rs. 5000
(b) Rs. 20000
(c) Rs. 3 lakhs
(d) Rs. 5 crore
3. For underwritten issues: If the issuing company does not receive the
minimum subscription of ninety per cent. of the offer through offer
document including devolvement of underwriters within how mny days
from the date of closure of the issue, the issuing company shall
forthwith refund the entire subscription
(a) 30
(b) 60
(c) 90
(d) 120
4. India being one of the largest growing economy in the world and pro
FDI policies by the government is becoming increasingly popular for
foreign direct investments as well as raising of capital from Indian
investors. Which of the following can be considered as a benefit of IDR
for Indian investors?
(a) Better investment portfolio diversification
(b) Can easily claim their rights relating to the IDR issuance
(c) Can take advantage of any arbitrage opportunity
! !392
5. The Foreign Issuing Company can also issue IDRs to non-residents after
seeking prior approval from RBI. Employees of the Issuing Company are
covered under the category of retail investors and are eligible to
subscribe to IDRs. State whether the above statement is true or false.
(a) True
(b) False
Ans: 1 - (c), 2 - (b), 3 - (b), 4 - (d), 5 - (a)
10.6 References
1. Foreign Institutional Investors (FIIs) & Capital Market in India by

Kulwant Singh Phull
2. Investing in India: A Value Investor's Guide to the Biggest Untapped

Opportunity in the World (Wiley Finance) by Rahul Saraogi
3. Outward Foreign Direct Investment (FDI) in Emerging Market Economies

by Tomasz Dorozynski and Anetta Kuna-Marszalek
4. Foreign Direct Investment (FDI)and Economic Growth in Emerging

Markets by Aliyu Mohammed Basheer
5. International Investments in Private Equity: Asset Allocation, Markets,

and Industry Structure by Peter Klaus Cornelius
6. Private Equity in Emerging Markets: The New Frontiers of International

Finance by Darek Klonowski
7. Investments by Zvi Bodie, Alex Kane, Alan J. Marcus, Pitabas Mohanty
! !393
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !394

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Investment Management – II

Sub Code - 657

Program Design and Advisory Team

Prof. B.N. Chatterjee Mr. Manish Pitke

Prof. Kanu Doshi Prof. B.N. Chatterjee

Prof. Dr. V.H. Iyer Mr. Smitesh Bhosale

Prof. B.N. Chatterjee Prof. Vineel Bhurke

Prof. Venkat lyer Dr. Pravin Kumar Agrawal

Prof. Dr. Pradeep Pendse Mrs. Margaret Vas

Prof. Sandeep Kelkar Mr. Anuj Pandey

Prof. Dr. Swapna Pradhan Course Editor

Prof. Bijoy B. Bhattacharyya Prof. B.N. Chatterjee

Mr. P.M. Bendre Course Coordinators

Mr. Ajay Prabhu Ms. Kirti Sampat

Mr. A.S. Pillai Mr. Kishor Tamhankar

COPYRIGHT © by Prin. L.N. Welingkar Institute of Management Development & Research.

NOT FOR SALE. FOR PRIVATE CIRCULATION ONLY.

1st Edition, May 2019

Chapter No. Chapter Name Page No.

1 Introduction to Investment Management 4-24

This chapter will help you understand basic objectives of investment,

1.2 Difference between Savings and Investing

1.3 Objectives of Investment

1.4 The Nature of Investment

1.5 Wide Range of Investment Choices

1.6 Factors Affecting Investments

1.7 Difference between Investment, Speculation and Gambling

1.8 Investment Risk

1.9 Portfolio Management

1.10 Activities for Students

1.12 Self Assessment Questions

Warren Buffet Says

Investing can be both rewarding and enjoyable experience if the investor

1.2 Difference between Savings and Investing

The fundamental psychological law propounded by John Meynard

Ideally, the best savings equation should be: Income – Savings =

and NOT: Income – Expenses = Savings

Unfortunately deployment of this simple savings strategy is not

According to Modigliani’s Life Cycle Theory people make intelligent

Investment means the utilization of the money that is saved.

Investment in broader terms means putting the money saved in income or

It is a part of income, which is not Results into purchase of an asset to

One saves by reducing present One invests by sacrificing the

Intended to meet financial goals Involves risk diversification and

Saving is risk less and very safe Investment involves risk

1.3 Objectives of Investment

An investment is made to accomplish an objective for an investor.

Investment Financial Goals are Achieved by Optimizing Following

1. Safety: The safest investments are expected to preserve the invested

3. Liquidity: Results are in the form of quick conversion of investments

4. Income stability and regularity of income after taxes

5. Legal safeguards and approval by law: assures return of money

The basic purpose of defining investment objectives is to identify the

Inorder to select the right investment vehicles, an investor has to gain as

1.4 The nature of Investment

The nature of investment is based on the investment objective of the

Regular Investment: Periodic investment to build a corpus required for

Short Term Investment: For achieving financial goals within a period of 3

Long Term Investment: For achieving financial goals after 5 years