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  • Commercial Bills: Meaning, Types, and Advantages

    Commercial Bills: Meaning, Types, and Advantages

    A Commercial Bill is one which arises out of a genuine trade transaction, i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. As well as discuss the Treasury Bills, this article explains Commercial Bills. The Commercial Bills explain in their key points; meaning, types, and advantages. The buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. Thus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum, to a certain person, after a creation period. A bill of exchange is a “self-liquidating” paper and negotiable/it is drawn always for a short period ranging between 3 months and 6 months.

    Explain and Learn, Commercial Bills: Meaning, Types, and Advantages!

    Meaning of Commercial Bills Market:

    The commercial bills are issued by the seller (drawer) on the buyer (drawee) for the value of goods delivered by him. These bills are for 30 days, 60 days or 90 days maturity. If the seller needs funds, he may draw a bill and send it to the buyer for the seller needs funds, he may draw a bill and send it to the buyer for acceptance.

    The buyer accepts the bill and promises to make the payment on the due date. He may also approach his bank to accept the bill. The bank charges a commission for the acceptance of the bill and promises to make the payment if the buyer defaults. Once this process is accomplished, the seller can sell it in the market. This way a commercial bill becomes a marketable investment.

    Usually, the seller will go to the bank for discounting the bill. The bank will pay him after deducting the interest for the remaining period of the bill and service charges from the face value of the bill. The interest rate is called the discount rate on the bills. The commercial bill market is an important channel for providing short-term finance to business.

    However, the instrument did not become popular because of two factors:

    1. Cash credit scheme is still the main form of bank lending, and
    2. Big buyers in the corporate sector are still unwilling to the payment mode of commercial bills.

    Definition of Bill of Exchange:

    “An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to the beater of the instrument”.

    What is a Bill of Exchange?

    According to section 5 of the Negotiable Instruments Act, 1881, defines Bill Of Exchange as,

    “A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument.”

    A promise or order to pay is not “conditional”, within the meaning of this section and section 4, by reason of the time for payment of the amount of any installment thereof being expressed to be on the lapse of certain period after the occurrence of a specified event which, according to the ordinary expectation of humanity, is certain to happen, although the time of its happening may be uncertain.

    The sum payable may be “certain”, within the meaning of this section and section and section 4, although it includes future indicated rater of change, or is according to the course of exchange, or is according to the course of exchange, and although the instrument provides that, on default of payment of an installment, the balance unpaid shall become due.

    The person to whom it is clear that the direction is given or that payment is to make maybe a “certain person,” within the meaning of this section and section 4, although he misnames or designated by description only.

    Types of Commercial Bills:

    Many types of commercial bills are in circulation in a bills market. They can broadly classify as follows:

    Demand and Using Bills: 

    Demand bills are others call sight bills. These bills are payable immediately as soon as they present to the drawer. No time of payment specify and hence they are payable at sight. Using bills call time bills. These bills are payable immediately after the expiry of the period mentioned in the bills. The period varies according to the established trade custom or usage prevailing in the country.

    Clean Bills and Documentary Bills: 

    When bills have to be accompanied by documents of title to goods like Railways, receipt, Lorry receipt, Bill of Lading, etc. the bills call documentary bills. These bills can further classify into D/A bills and D/P bills. In the case of D/A bills, the documents accompanying bills have to deliver to the drawee immediately after acceptance. Generally, D/A bills draw on parties who have good financial standing.

    On the order hand, the documents have to hand over to the drawee only against payment in the case of D/P bills. The documents will retain by the banker. Till the payment of such bills. When bills are drawn without accompanying any documents they are called clean bills. In such a case, documents will be directly sent to the Drawee.

    Inland and Foreign Bills: 

    Inland bills are those drawn upon a person resident in India and are payable in India. Foreign bills draw outside India and they may be payable either in India or outside India. They may draw upon a person resident in India also. Foreign boils have their origin outside India. They also include bills draw on India make payable outside India.

    Export and Foreign Bills: 

    Export bills are those draw by Indian exports on importers outside India and import bills draw on Indian importers in India by exports outside India.

    Indigenous Bills: 

    Indigenous bills are those draw and accept according to native custom or usage of trade. These bills are popular among indigenous bankers only. In India, they call “Hundis” the Hundis knows by various names such as – Shah Jog, Nam Jog, Jokhani, Termainjog, Darshani, Dhanijog, and so on.

    Accommodation Bills and Supply Bills: 

    If bills do not arise out of genuine trade transactions, they call accommodation bills. They know as “kite bills” or “wind bills”. Two parties draw bills on each other purely for mutual financial accommodation. These bills are discount with bankers and the proceeds are sharing among themselves. On the due dates, they are paying.

    Supply bills are those neither draw by suppliers or contractors on the government departments for the goods nor accompanied by documents of title to goods. So, they do not consider as negotiable instruments. These bills are useful only to get advances from commercial banks by creating a charge on these bills.

    Operations in Commercial Bills Market:

    From the operations point of view, the bills market can classify into two viz.

    • Discount Market
    • Acceptance Market
    Discount Market:

    Discount market refers to the market where short-term genuine trade bills discounts by financial intermediaries like commercial banks. When credit sales affect, the seller draws a bill on the buyer who accepts it promising to pay the specified sum at the specified period. The seller has to wait until the maturity of the bill for getting payment. But, the presence of a bill market enables him to get paid immediately.

    The seller can ensure payment immediately by discounting the bill with some financial intermediary by paying a small amount of money called “Discount rate” on the date of maturity, the intermediary claims the amount of the bill from the person who has accepted the bill. In some countries, some financial intermediaries specialize in the field of discount.

    For instance, in the London Money Market, there are specializing in the field discounting bills. Such institutions are conspicuously absent in India. Hence, commercial banks in India have to undertake the work of discounting. However, the DFHI has been establishing to activate this market.

    Acceptance Market:

    The acceptance market refers to the market where short-term genuine trade bills accept by financial intermediaries. All trade bills cannot discount easily because the parties to the bills may not be financially sound. In case such bills accept by financial intermediaries like banks, the bills earn a good name and reputation and such bills can readily discount anywhere.

    In London, there are specialist firms call acceptance house which accepts bills draw by trades and import greater marketability to such bills. However, their importance has declined in recent times. In India, there are no acceptance houses. The commercial banks undertake the acceptance business to some extent.

    Advantages of Commercial Bills:

    Commercial bill market is an important source of short-term funds for trade and industry. It provides liquidity and activates the money market. In India, commercial banks lay a significant role in this market due to the following advantages:

    Liquidity:

    Bills are highly liquid assets. In times of necessity, bills can convert into cash readily using rediscounting them with the central bank. Bills are self-liquidating in character since they have fixed tenure. Moreover, they are negotiable instruments and hence they can transfer freely by mere delivery or by endorsement and delivery.

    The certainty of Payment:

    Bills draw and accept by business people. Generally, business people use to keeping their words and the use of the bills imposes strict financial discipline on them. Hence, bills would honor on the due date.

    Ideal Investment:

    Bills are for periods not exceeding 6 months. They represent advances for a definite period. This enables financial institutions to invest their surplus funds profitably by selecting bills of different maturities. For instance, commercial banks can invest their funds on bills in such a way that the maturity of these bills may coincide with the maturity of their fixed deposits.

    In the case of the bills dishonor, the legal remedy is simple. Such dishonor bills have to simply note and protest and the whole amount should debit to the customer’s accounts.

    High and Quick Yield:

    The financial institutions earn a high quick yield. The discount dedicates at the time of discounting itself whereas, in the case of other loans and advances, interest is payable only when it is due. The discounts rate is also comparatively high.

    Easy Central Bank Control:

    The central bank can easily influence the money market by manipulating the bank rate or the rediscounting rate. Suitable monetary policy can take by adjusting the bank rate depending upon the monetary conditions prevailing in the market.

    Commercial Bills_ Meaning Types and Advantages - ilearnlot
    Commercial Bills: Meaning, Types, and Advantages.

    Drawbacks of Commercial Bills:

    In spite of these merits, the bills market has not been well developing in India. The reasons for the slow growth are the following:

    The Absence of Bill Culture:

    Business people in India prefer O.D and cash credit to bill financing, therefore, banks usually accept bills for the conversion of cash credits and overdrafts of their customers. Hence bills are not popular.

    The absence of Rediscounting Among Banks:

    There is no practice of re-discounting of bills between banks who need funds and those who have surplus funds. To enlarge the rediscounting facility, the RBI has permitted financial institutions like LIC, UTI, GIC, and ICICI to rediscount genuine eligible trade bills of commercial banks. Even then, bill financial is not popular.

    Stamp Duty:

    Stamp duty discourages the use of bills. Moreover, stamp papers of the required denomination are not available.

    The Absence of Secondary Market:

    There is no active secondary market for bills. The rediscounting facility is available in important centers and that too restrictive to the apex level financial institutions. Hence, the size of the bills market has been curtail to a large extent.

    Difficulty in Ascertaining Genuine Trade Bills:

    The financial institutions have to verify the bills to ascertain whether they are genuine trade bills and not accommodation bills. For this purpose, invoices have to scrutinize. It involves additional work.

    Limited Foreign Trade:

    In many developed countries, bill markets have been establishing mainly for financing foreign trade. Unfortunately, in India, foreign trade as a percentage to national income remains small and it is reflected in the bill market also.

    The Absence of Acceptance Services:

    There is no discount house or acceptance house in India. Hence specialized services are not available in the field of discounting or acceptance.

    The attitude of Banks:

    Banks are shy about rediscounting bills even the central bank. They tend to hold the bills till maturity and hence it affects the velocity of the circulation of bills. Again, banks prefer to purchase bills instead of discounting them.

  • Treasury Bills: Meaning, Features, Types, and Importance

    Treasury Bills: Meaning, Features, Types, and Importance

    Just like commercial bills which represent commercial debt, treasury bills represent short-term borrowings of the Government. As well as discuss the Commercial Bills, this article explains Treasury Bills. The Treasury Bills explain in their key points; meaning, features, types, and importance. Treasury bill market refers to the market where treasury bills buy and sell. Treasury bills are very popular and enjoy a higher degree of liquidity since they issue by the government.

    Explain and Learn, Treasury Bills: Meaning, Features, Types, and Importance!

    Meaning and Features of Treasury Bills:

    A treasury bills nothing but promissory note issued by the Government under discount for a specified period stated therein. The Government promises to pay the specified amount mentioned therein to the beater of the instrument on the due date. The period does not exceed one year. It is purely a finance bill since it does not arise out of any trade transaction. It does not require any “grading” or “endorsement” or “acceptance” since it claims against the Government.

    Treasury bill issues only by the RBI on behalf of the Government. Treasury bills issue for meeting temporary Government deficits. The Treasury bill rate of discount is fixed by the RBI from time-to-time. It is the lowest one in the entire structure of interest rates in the country because of short-term maturity and degree of liquidity and security.

    Definition of Treasury Bills:

    Treasury Bills, also known as T-bills are the short-term money market instrument, issued by the central bank on behalf of the government to curb temporary liquidity shortfalls. These do not yield any interest, but issued at a discount, at its redemption price, and repaid at par when it gets matured.

    T-bills are the key segment of the financial market, which utilizes by the government to raise short-term funds, for fulfilling periodic discrepancies between its receipts and expenditure. The difference between the issue price and the redemption value indicates the interest on treasury bills, call as a discount. These are the safest investment instrument of its category, as the risk of default is negligible. Further, the date of issue predetermine, as well as the amount also fixed.

    Features of Treasury Bills:

    The following features of treasury bills below are;

    Form:

    T-bills are issued either in physical form as a promissory note or dematerialized form by a credit to Subsidiary General Ledger (SGL) Account.

    Eligibility:

    Individuals, firms, companies, trust, banks, insurance companies, provident funds, state government, and financial institutions are eligible to invest in treasury bills.

    Minimum Bid:

    The minimum amount of bid is Rs. 25000 and in multiples thereof.

    Issue price:

    T-bills are issued at a discount but redeemed at par.

    Repayment:

    The repayment of the bill is made at par on the maturity of the term.

    Availability:

    Treasury bills are highly liquid negotiable instruments, that are available in both financial markets, i.e. primary and secondary.

    Method of the auction:

    Uniform price auction method for 91 days T-bills, whereas multiple price auction method for 364 days T-bill.

    Day count:

    The day count is 364 days, in a year, for treasury bills.

    Besides this, other characteristics of treasury bills include the market-driven discount rate, selling through auction, issued to meet short-term mismatches in cash flows, assured yield, low transaction cost, etc.

    Types of Treasury Bills:

    In India, there are two types of treasury bills viz.

    • Ordinary or regular and
    • “Ad hoc” known as “Ad Hoc’s” ordinary treasury bills are issued to the public and other financial institutions for meeting the short-term financial requirements of the Central Government.

    These bills are freely marketable and they can buy and sell at any time and they have secondary market also.

    On the other hand ‘ad Hoc’s’ are always issued in favor of the RBI only. They are not sold through tender or auction. Also, they are purchased by the RBI on top and the RBI authorizes to issue currency notes against them.

    Government explains:

    They are marketable sell them back to the RBI. Ad Hoc’s serve the Government in the following ways:

    • They replenish the cash balances of the central Government. Just like State Government get advance (ways and means advances) from the RBI, the Central Government can raise finance through this Ad Hocs.
    • They also provide an investment medium for investing the temporary surpluses of State Government, semi-government departments and foreign central banks.

    Based on periodicity, treasury bills may classify into three they are:

    91 days T-bills:

    The tenor of these bills complete on 91 days. These are an auction on Wednesday, and the payment makes on the following Friday.

    182 days T-bills:

    These treasury bills get matured after 182 days, from the day of issue, and the auction is on Wednesday of non-reporting week. Moreover, these are repaying on following Friday, when the term expires.

    364 days T-bills:

    The maturity period of these bills is 364 days. The auction is on every Wednesday of reporting week and repay on the following Friday after the term gets over.

    Treasury bills are backed by some advantages like no tax deducted at source, high liquidity and trade-ability, zero risks of default, transparency, a good return on investment and so on.

    Ninety-one day’s treasury bills are issuing at a fixed discount rate of 4% as well as through auctions. 364 days bills do not carry any fixed rate. The discount rate on these bills quotes in the auction by the participants and accepted by the authorities. Such a rate calls cut off rate. In the same way, the rate is fixed for 91 days treasury bills sold through auction. 91 days treasury bills (top basis) can rediscount with the RBI at any time after 14 days of their purchase. Before 14 days a penal rate charges.

    Operations and Participants:

    The RBI holds day’s treasury bills (TBs) and they issue on top basis throughout the week. However, 364 days TBs are selling through the auction which conducts once in a fortnight. The date of auction and the last date of submission of tenders are notified by the RBI through a press release. Investors can submit more than one bid also.

    On the next working day of the date auction, the accepted bids with prices are displaying. The successful bidders have to collect letters of acceptance from the RBI and deposit the same along with the cheque for the amount due on RBI within 24 hours of the announcement of auction results.

    Institutional investors like commercial banks, DFHI, STCI, etc, maintain a subsidiary General Ledger (SGL) account with the RBI. Purchases and sales of TBs are automatically recording in this account invests who do not have SGL account can purchase and sell TBs through DFHI. The DFHI does this function on behalf of investors with the bits of the help of SGL transfer forms. The DFHI is actively participating in the auctions of TBs.

    It is playing a significant role in the secondary market also by quoting daily buying and selling rates. It also gives buy-back and sell-back facilities for the period’s up to 14 days at an agreed rate of interest to institutional investors. The establishment of the DFHI has imported greater liquidity in the TB market.

    The participants in this market are the followers:
    1. RBI and SBI.
    2. Commercial banks.
    3. State Governments.
    4. DFHI.
    5. STCI.
    6. Financial institutions like LIC, GIC, UTI, IDBI, ICICI, IFCI, NABARD, etc.
    7. Corporate customers, and.
    8. Public.

    Through many participants are there, in actual practice, this market is in the hands of the banking sector. It accounts for nearly 90 % of the annual sale of TBs.

    Importance of Treasury Bills:

    The following importance of treasury bills below is:

    Safety:

    Investments in TBs are highly safe since the payment of interest and repayment of principal are assured by the Government. They carry zero default risk since they are issuing by the RBI for and on behalf of the Central Government.

    Liquidity: 

    Investments in TBs are also highly liquid because they can convert into cash at any time at the option of the inverts. The DFHI announces daily buying and selling rates for TBs. They can discount with the RBI and further refinance facility is available from the RBI against TBs. Hence there is a market for TBs.

    Ideal Short-Term Investment:

    Idle cash can profitably invest for a very short period in TBs. TBs are available on top throughout the week at specified rates. Financial institutions can employ their surplus funds on any day. The yield on TBs also assures.

    Ideal Fund Management:

    TBs are available on top as well through periodical auctions. They are also available in the secondary market. Fund managers of financial institutions build the portfolio of TBs in such a way that the dates of maturities of TBs may match with the dates of payment on their liabilities like deposits of short-term maturities. Thus, TBs help financial manager’s it manages the funds effectively and profitably.

    Statutory Liquidity Requirement:

    As per the RBI directives, commercial banks have to maintain SLR (Statutory Liquidity Ratio) and for measuring this ratio of investments in TBs takes into account. TBs are eligible securities for SLR purposes. Moreover, to maintain CRR (Cash Reserve Ratio). TBs are very helpful. They can readily convert into cash and thereby CRR can maintain.

    Source of Short-Term Funds:

    The Government can raise short-term funds for meeting its temporary budget deficits through the issue of TBs. It is a source of cheap finance to the Government since the discount rates are very low.

    Non-Inflationary Monetary Tool:

    TBs enable the Central Government to support its monetary policy in the economy. For instance excess liquidity, if any, in the economy can absorb through the issue of TBs. Moreover, TBs are subscribing by investors other than the RBI. Hence they cannot mention and their issue does not lead to any inflationary pressure at all.

    Hedging Facility:

    TBs can use as a hedge against heavy interest rate fluctuations in the call loan market. When the call rates are very high, money can raise quickly against TBs and invest in the call money market and vice versa. TBs can use in ready forward transitions.

    Defects of Treasury Bills:

    The following defects of treasury bills below are;

    Poor Yield:

    The yield form TBs is the lowest. Long-term Government securities fetch more interest and hence subscriptions for TBs are on the decline in recent times.

    Absence Of Competitive Bids:

    Though TBs sell through auction to ensure market rates for the investors, in actual practice, competitive bids are conspicuously absent. The RBI compels to accept these non-competitive bids. Hence adequate return is not available. It makes TBs unpopular.

    Absence Of Active Trading:

    Generally, the investors hold TBs till maturity and they do not come for circulation. Hence, active trading in TBs adversely affects.

  • Explain How to Investment in Mutual Funds?

    Learn and Study, Explain How to Investment in Mutual Funds?

    Mutual fund companies, also known as Asset Management Companies (AMCs) collect funds from the public (mainly from small investors) and invest such funds in the market and distribute returns/surpluses in the form of dividends. Surpluses can also be reflected in higher Net Asset Value (NAV) of the scheme. In simple words, a mutual fund company collects savings of small investors (pool their money); the fund managers of the concern invest such pool of funds to market (securities); when returns are generated from such investment, passed back to the investors. Also learned, Process of Investment, Explain How to Investment in Mutual Funds?

    This is how a mutual fund works. First, an offer document (containing details of the scheme, its investment horizon, and class (ES) of securities it intends to invest etc.) is issued to the public. Then the collected money is pooled together to constitute a fund. This fund is managed by fund managers of AMC who take major investment decisions. A trust takes care that the mutual fund investments are in accordance with the scheme of the fund and is being managed in the interest of the investors. The returns from such investment activities are distributed in accordance with the scheme of the fund.

    NAV of a mutual fund (or in other words NAV per unit) refers to the total asset managed by the fund at its market value divided by the number of outstanding (issued and sold) units of the fund. For instance, a fund having net asset worth of Rs.100 crores and Rs.10 crore units are outstanding then the NAV per unit of the fund would be Rs.10. The NAV of a scheme depends on the market value of its investments and hence it fluctuates with the fluctuating share prices of its investment. An increase in NAV means capital appreciation for investors.

    Since mutual funds are managed by professionals who have requisite experiences and qualifications in the areas of the stock market, as far as a new entrant in the stock markets is concerned, these funds act as a safe vehicle for investment. Moreover, as mutual funds invest in a number of scrips, the impact of risks associated with individual securities is minimized. To put in financial language, the aim is to diversify the unsystematic risk in the portfolio. Also, since the pooled funds are invested in different sectors and stocks, there is a diversification effect reducing the overall risk of the portfolio.

    Since mutual funds generally trade in a large number of securities at the same time, there is the advantage of economies of scale. In other words, there are savings in transaction costs.

    According to the investment objective, mutual funds can be classified as (a) growth funds, (b) income funds and (c) balanced funds. Growth funds invest the majority of their pooled amount with the objective of achieving long-term capital appreciation. Income funds provide periodic returns to investors in the form of dividends. Balanced funds are a midway between growth funds and income funds. They balance their investment in such a way that investors not only get the periodical return, but their capital also tends to appreciate which is reflected in the higher NAV.

    If you are an investor who seeks for a suitable fund, then it depends on your risk-bearing capacity (your risk profile). If you are a high risk-averse investor who requires the periodic return, then you should always prefer investment in income funds. If you have a high risk taking capability and you have surplus funds to invest, then go for growth funds. If you want a small periodic return along with capital appreciation, then go for balanced funds.

    Investment in mutual funds should never be looked upon from the point of view of return. It is the risk-return paradigm which can help us to optimize our return over a period of time. Another point you should remember is that you should never attempt to compare two schemes of the mutual fund with different investment objectives on the basis of the returns provided by them, if you do so, it would be like comparing apples with mangoes.

    Sharpe ratio and Treynor Ratio are the tools to measure the performance of mutual funds over a period of time. Sharpe Ratio is obtained by dividing the difference between the return of the portfolio and risk-free rate of interest to the standard deviation of the portfolio return. This ratio takes into account surplus return earned by the fund over risk-free rate of interest and then divides it by standard deviation of the portfolio return (which is basically a representative of risk which measures the deviation of actual return of the portfolio with respect to mean return).

    Higher the return better is the fund. Treynor Ratio also takes into account surplus return earned over risk-free return but the measure of risk here is beta (a measure of systematic risk) rather than standard deviation. Thus, Treynor ratio is obtained by dividing the difference between the return of the portfolio and risk-free rate of interest to the beta (market risk/systematic risk) of the portfolio.

    There are some absolute performance measures such as Jenson’s Alpha, Fama’s Measure and Expense Ratio which provide an indication about the performance of a mutual fund as a whole. Jenson’s Alpha Measure helps us in identifying whether the fund has been able to outsmart its expected return.

    The expected return of a security is equal to:

    Re = Rf + β(Rm – Rf)

    Where Rf is the risk-free return, β is the systematic risk and Rm is the return on market index (return earned by the fund).

    Fama’s measure is obtained by the following formula:

    Fama’s Measure = Rp – [Rf + (σp/σm)(Rm – Rf)]

    Where, Rp = actual return of portfolio; Rf = risk free return, Rm = return on market index, σp = standard deviation of portfolio return, σm = standard deviation of market index return.

    Thus, instead of β, which takes into account only systematic risk, this measure takes into account standard deviation of stock return as well as standard deviation of market returns.

    Expense ratio refers to the total amount of expenses of the fund as a percentage of total assets of the fund. The expenses include all the charges in the form of administrative overheads, salary of staff etc. However, expenses do not include brokerage.

    The return on mutual funds is never equal to the return on securities which the investor can earn if he invests directly in those securities since there are front-end load, back-end load and annual expenses which will be deducted from the fund. Front-end fee is charged by the AMC at the time of initial investment in the fund. Exit load is the number of fees charged at the time of redemption (surrender) of the unit. Generally, funds which charge front-end fees do not charge back-end fees/exit load. Moreover, there are expenses which are deducted annually for meeting administrative and other expenses of the fund.

    Mutual fund schemes can be in the form of open-ended schemes or closed-ended schemes. In closed-ended schemes, a fixed number of units are issued by the fund and thereafter this number remains constant till the maturity of the scheme. The option available to the investors, in this case, is that they can buy and sell the units in the secondary market. The open-ended schemes are without any fixed number of outstanding units. Any investor can invest money in accordance with the NAV of the scheme any time. Similarly, investors get an opportunity to redeem their units any time. The logic here is that since there is no fixed total number of units, mutual fund not only accepts money for investment purpose later on after the scheme is launched but also redeems units of holders as and when required by them.

    Finally, there are index funds, ETFs and Fund of Funds, which should also be analyzed. Index funds are those funds which create a portfolio which replicates the composition of a particular index. For instance, an index fund on NIFTY will invest in all those securities which are a part of that index and the proportion is also similar to the weights which the individual securities have in that index. Thus these funds tend to replicate the performance of that index. If we put it in financial language, these funds create a portfolio with a β of 1 which exactly matches the performance of the market.

    For Example:

    When the market i.e. SENSEX moves up by 15% over a time period, the portfolio value also rises by 15% (or rather is expected to rise). This is because the securities which have been purchased by this fund are a part of that index and have been purchased in the same proportion as is the weight of those securities in the index. If an investor intends to have a complete elimination of unsystematic risk, i.e. he wants to earn a return which the index earns irrespective of the performance of individual stocks in the market he should invest in such funds.

    Exchange traded funds or popularly known as ETFs are mutual funds whose units are traded in stock exchanges. Unlike the traditional funds in which units are directly redeemed by the mutual fund itself, the units of these funds are bought and sold in the market just like shares. These funds may be open-ended or closed-ended. The investors of ETFs do need to have a Demat account.

    There are ETFs which are traded on stock exchanges with the underlying asset as gold, known as ‘Gold Exchanged traded Fund’. They provide a convenient and easy vehicle for retail investors to participate in the gold bullion market. Thus the fund issues a certificate for the specified amount of gold to its unitholders. The scheme is listed on a stock exchange and hence investors can buy and sell the units on the stock exchange. The advantage here is that there is no risk of holding physical gold stock and the investor can still have a notional claim over units of gold.

    There are also mutual funds which invest in other mutual funds and these mutual funds are known as the fund of funds. Thus, instead of directly investing in securities of corporates or bonds, these mutual funds invest I other mutual funds in order to get maximum diversification.

  • What is Dividend Investing? Meaning, Definition, and Example!

    Learn, What is Dividend Investing? Meaning, Definition, and Example!

    For those who are still considered greenhorns in the investment world, a dividend is a payment distributed by a company to all its shareholders. For the longest time, dividend investing has been a permanent fixture in wealth building and wealth management programs because of the kind of financial security it provides. An investor and expert financial planner earns in divided investments through dividend payments, which forms part of a company’s profit. Also learned, Mutual Funds, What is Dividend Investing? Meaning, Definition, and Example!

    Meaning:

    Each quarter, on the dividend declaration date, a firm’s board of directors declares the dividend amount that will be distributed to the firm’s shareholders. Only the shareholders who owned the stock on the dividend record date, i.e. the date that the firm reviews its lists to determine the shareholders of record, receive a dividend. Shareholders who do not own the stock on the dividend record date are not entitled to receive a dividend.

    Likewise, investors who buy the stock on or after the ex-dividend date do not receive the firm’s dividend. Usually, dividend investors are interested in a firm’s dividend payout ratio and dividend yield. A dividend payout ratio between 40% and 50% indicates that the firm distributes almost half of its retained earnings to its shareholders while the remaining is invested in the launch of a new product or to lower the short-term debt. The dividend yield may lead to a large cash income.

    Definition:

    Dividend investing is an investment approach to purchasing stocks that issue dividends in an effort to generate a steady stream of passive income. Companies distribute cash dividends to their shareholders periodically during their fiscal year, but most issue them on a quarterly basis. “Dividend investing is an investment strategy of only buying stocks that issue dividends thus creating a reoccurring income stream.”

    The other profit portion not distributed to the investors will be pumped back into the capitalization used to fuel the operation of the company.
    • Most wealth management and wealth building programs include dividend investing. To place investments strategically, a professional financial planner would be necessary. One who deals with dividend investing would need the expertise provided by a financial planner when playing with the rise and fall of share prices.
    • With dividend investing as part of an individual’s wealth building and wealth management portfolio, a consistent flow of passive income is produced which the investor and financial planner can opt to spend or reinvest in the same venture to increase shares or place in other forms of investment. That is the reason why most retirees love investing in dividends – the supplemental income plus the excitement that market assumption brings.
    • Only when a company has reached a high level of marketing success will it only decide to pay dividends. This means that investing in a company that pays dividends is investing in a stable company. With bigger rewards and very little financial risks, dividend investing is really one of the best wealth building and wealth management strategy options. Dividend investing offers two ways of earning profits: getting dividend payments and increase in share prices which mean bigger return on investment when one decides to sell his shares.
    • With dividend investments, one gets a better deal with his money. It improves his wealth building and wealth management portfolio which raises his assets worth. Plus, he still retains part ownership of the company while collecting profits at the same time. An investor, as well as a financial planner, has the option of increasing his number of shares by reinvesting his dividends. He does not even have to shell out extra cash to buy new stocks and shares.
    • Investments in dividends can function as a barricade against inflation. Dividends can offset losses in other business as a result of the increase in the prices of products. High prices mean more earnings which also translate to bigger dividends.
    • Dividends are typically taxed lower compared to regular income. This means more savings on taxes paid to the government.

    Today, a lot of senior citizens rely on their investments on dividends in sustaining them with their daily needs. The dividends coming from stable companies are as consistent as night and day and it provides the opportunity of receiving cash right out the investments that they made without having to cash in on their shares. Or, they can beef up their shares by reinvesting the profits that they earn when they feel they do not need the extra cash at the moment (as a trusted financial planner would often say).

    For Example:

    A steel manufacturing firm has released its quarterly results and has a net income of $250 million. The board of directors decides to pay $120 million in cash dividend and reinvest $130 million in lowering its short-term debt. This means that the firm’s dividend payout ratio is dividend / net income = $120 million / $250 million = 48%.

    The board of directors declares a quarterly dividend of $0.95 per share, reaching an annualized dividend of $3.8 per share. The stock currently trades at $88; therefore, the dividend yield of the stock is dividend / stock price = $3.8 / $88 = 4.32%. A shareholder that holds 10,000 shares will be compensated with 10,000 x 4.32% = $432.

    On the ex-dividend date, the stock price declines to adjust to the dividend paid. Therefore, the firm’s stock that trades at $88, and pays a quarterly dividend of $0.95 per share, ceteris paribus, the stock will open at $88 – $0.97 = $87.03 on the ex-dividend date.

  • Explain How to Calculate NAV in Mutual Funds?

    Explain How to Calculate NAV in Mutual Funds?

    Learn, Explain How to Calculate NAV in Mutual Funds?

    The Net Asset Value (NAV) is the market value of the assets of the scheme deducting its liabilities. Simply put, the NAV is what investors are required to pay to buy or sell one share of the mutual fund. Keep in mind any additional fees are not included in this amount. In accounting terms, NAV is also known as the book value of the mutual fund. Also Learned, Mutual Funds, Explain How to Calculate NAV in Mutual Funds?

     

    The net asset value per mutual fund unit on any business day is computed as follows:

    NAV = (Market value of the fund’s investments + Receivables + Accrued income -Liabilities – Accrued expenses)/Number of units outstanding.

    Rules Governing the Mutual Fund NAV Calculation:

    1. Accrued Income and Expenses: The correct accrual of all incomes and expenses is a requirement for computing NAV. In practical terms, these are just estimates. For example, the investment manager’s fees have to be accrued every day for computing NAV but the fee is based on the weekly average of net assets. Changes in NAV due to the assumptions about accruals should not impact NAV by more than 1 %.
    2. Sale and Purchase of Securities and Units: The purchase and sale of securities have to be recorded in the books of the fund, and this impacts the net assets of the fund. Sale and repurchase of units alter the number of unitholders outstanding in the fund and impacts the denominator of the NAV equation.
    3. Initial Expenses: When a mutual fund scheme is launched, certain expenses are incurred. These relate to printing and mailing, advertisements, commission to agents, brokerage, stamp duty, marketing, and administration known as initial or pre-operational expenses, they are linked to the corpus of the scheme. The fund has to give a break up of these expenses in the prospectus.
    4. Recurring Expenses: Apart from the initial expenses, mutual funds incur recurring expenses every year. These expenses include items like the asset management fees, registrar’s fees, and custodial fees and are charged to the profit and loss account of the scheme.
    5. Sales and Repurchase Load: Sales or front-end load is a charge collected by a scheme when it undertakes fresh issue of units or shares. Suppose a mutual fund issues Rs.1,00,000 worth units having a face value of Rs.10 each. The company incurs some initial issue expenses, which may be around 1% of the face value, or in other words, the company may levy an entry load. Schemes that do not charge a load are called ‘No Load’ schemes. Repurchase or ‘Back-end’ load is a charge collected by a scheme when it buys back the units from the unit holders. It is because of the front-end and back-end loads the mutual fund schemes are at a premium and repurchased at a discount to NAV. The repurchase price is usually less than the reissue price.

    Learn how to calculate Net Asset Value with the following examples:

    • Example 1: If the net assets of a fund are $10 million, and the fund holds 2 million shares. Then, the NAV per share = $5 ($10 million / 2 million).
    • Example 2: YTC Corporation has total assets of $3,500,000 (including intangible asset $500,000) and total liabilities of $1,000,000. The calculation for net asset value of ABC corporation is as follows: NAV = total assets – intangible assets – total liabilities = 3,500,000 – $500,000 – $1,000,000 = $2,000,000
    • Example 3: A mutual fund has total assets of $2,800,000, liabilities of $800,000, and 200,000 outstanding shares. Then, the NAV per share = (2,800,000 – 800,000) / 200,000 = $10.
    NAV in Brief:

    The Net Asset Value (NAV) of a mutual fund is the price at which units of a mutual fund are bought or sold. It is the market value of the fund after deducting its liabilities. The value of all units of a mutual fund portfolio is calculated on a daily basis, from this all expenses are then subtracted. The result is then divided by the total number of units the resultant value is the NAV. NAV is also sometimes referred to as Net Book Value or book Value. Let’s discuss its calculation in a bit more detail.

    NAV indicates the market value of the units in a fund. So, it helps an investor keep track of the performance of the mutual fund. An investor can calculate the actual increase in the value of their investment by determining the percentage increase in the mutual fund NAV. NAV, therefore, gives accurate information about the performance of the mutual fund.

    Calculation of NAV:

    Mutual fund assets usually fall into two categories – securities & cash. Securities, here, include both bonds and stocks. Therefore, the total asset value of a fund will include its stocks, cash, and bonds at market value. Dividends and interest accrued and liquid assets are also included in total assets.

    Explain How to Calculate NAV in Mutual Funds - ilearnlot

    Also, liabilities like money owed to creditors, and other expenses accrued are also included.

    Now the formula is:

    Net Asset Value (NAV) = (Assets – Debts) / (Number of Outstanding units).

    Here:

    Assets = Market value of mutual fund investments + Receivables + Accrued Income

    Debts = Liabilities + Expenses (accrued)

    The market value of the stocks & debentures is usually the closing price on the stock exchange where these are listed.

    Some points to note:

    The mutual fund itself and/or certain accounting firms calculate the NAV of a mutual fund.

    Since mutual funds depend on stock markets, they are usually declared after the closing hours of the exchange.

    All Mutual Funds are required to publish their NAV at every business day as per SEBI guidelines.

    Also, NAV is obtained by subtracting the expense ratio of a fund. This expense ratio is the total of all expenses made by the mutual fund annually, including the operating expenses and the management fees, distribution and marketing fees, transfer agent fees, custodian fees and audit fees.

  • What are a Mutual Funds?

    What are a Mutual Funds?

    Learn and Study, What are a Mutual Funds?

    A Mutual Fund is a special type of investment institution which collects or pools the savings of the community and invests large funds in the variety of Blue-chip Companies which are selected from a wide range of industries with the objects of maximizing returns/incomes on investments. Mutual Funds are basically a trust which mobilizes savings from the people and invests them in a mix of corporate and government securities. Money collected by the investors is invested in various issues of primary and secondary markets in order to gain profits on such investments. Also learned, the Process of Investment, What are a Mutual Funds?

    What are a Mutual Funds - ilearnlot

    A Mutual Fund is a Trust, which combines the investments of various investors having similar financial goals. The Trust issues units to the investors in the proportion of their investments. A fund manager then invests these funds in different types of assets, which provide returns in the form of dividends, interests, and capital appreciation. This is distributed to the various investors in the proportion of their contribution to the pool funds. Ordinary investors, who want to invest their savings, neither understand the complexities of financial markets nor have the time to watch, research and analyze different equities, securities or any other investments opportunities that are available in the market.

    At present, all the markets viz. the debt market, the equity market, the money market, real estates, derivatives, and the market dealing with the other assets have now reached a stage where a minimal information affect the markets. Besides this, the economy has opened up and global events influence their performance.

    It is very difficult for a layperson to keep track of various investments, transactions, brokerages etc. In the present scenario, mutual funds are some of the most efficient financial instruments as it offers services like managing investments at a very low cost.

    What is NAV or Net Asset Value?

    NAV of the Fund is the market value of all the assets of the Fund subtracting the Liabilities. NAV reflects the Fund that will be available to the shareholders if the Fund is liquidated and all the liabilities are paid. In the mutual fund industry NAV refers to Net Asset Value per unitholder, which NAV of the Fund divided by the outstanding number of the units.

    It shows the performance of the Fund.

    • Calculation of NAV = Net Asset Value of the fund sum of market value of shares/debentures + Liquid assets/cash Dividends/interest accrued – All liabilities
    • Net asset value per unit =NAV of the fund / Outstanding number of units

    The market value of the shares and debentures is calculated by multiplying the number of shares/units by the closing price of the shares/debentures. The closing price will be of the previous day of the stock exchange from where the shares have been purchased.

    If the shares were not traded on the previous day in that stock exchange, then the closing price of the shares of any other stock exchange is taken where the shares were traded. If the shares were not traded on any stock exchange the previous day, then the closing price of the shares when they were last traded is taken.

    For untraded shares, the value has to be determined by the other methods such as Book Value, comparable company approach, etc. Value of the illiquid bond is estimated on the basis of yields of comparable liquid bonds.

    To many people, Mutual Funds can seem complicated or intimidating. We are going to try and simplify it for you at its very basic level. Essentially, the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. This fund is managed by a professional fund manager.

    It is a trust that collects money from a number of investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor owns units, which represent a portion of the holdings of the fund. 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 or NAV. Simply put, a Mutual Fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

  • What is the Concept of Investment? Saving and Investing

    What is the Concept of Investment? Saving and Investing

    Concept of Investment – Investment is the employment of funds to get the return on it. In general terms, investment means the use of money in the hope of making more money. In finance, investment means the purchase of a financial product or another item of value with an expectation of favorable future returns. A study, PDF Reader with free Download PDF File. Also learn, Two Types: economic and financial investment, Difference between Saving and Investing, GST, What is the Concept of Investment?

    Learn and Understand, What is the Concept of Investment?

    What is Investment? An investment is an asset or item acquired to generate income or appreciation. In an economic sense, an investment is the purchase of goods that do not consume today but use in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later sell at a higher price for a profit, mutual funds.

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    Investment of hard-earned money is a crucial activity of every human being. Also, Investment is the commitment of funds that have been saved from current consumption with the hope that some benefits will be received in the future. Thus, it is a reward for waiting for money. Savings of the people invest in assets depending on their risk and return demands. Also Importance, Industrial Relations!

    Investment refers to the concept of deferred consumption, which involves purchasing an asset, giving a loan, or keeping funds in a bank account to generate future returns. Various investment options are available, offering differing risk-reward tradeoffs. An understanding of the core concepts and a thorough analysis of the options can help an investor create a portfolio that maximizes returns while minimizing risk exposure.

    There are two concepts of Investment:

    Economic Investment:

    The concept of economic investment means an addition to the capital stock of the society. Also, The capital stock of the society is the goods that use in the production of other goods. The term investment implies the formation of new and productive capital in the form of new construction; and, producers of durable instruments such as plants and machinery. Also, Inventories and human capital include in this concept. Thus, an investment, in economic terms, means an increase in building, equipment, and inventory.

    Financial Investment:

    This is an allocation of monetary resources to assets that expect to yield some gain or return over a given period of time. It means an exchange of financial claims such as shares and bonds, real estate, etc. Financial investment involves contracts written on pieces of paper such as shares and debentures. People invest their funds in shares, debentures, fixed deposits, national saving certificates, life insurance policies, provident fund, etc. in their view investment is a commitment of funds to derive future income in the form of interest, dividends, rent, premiums, pension benefits and the appreciation of the value of their principal capital. In primitive economies, most investments are of the real variety whereas in a modern economy much investment is of the financial variety.

    The economic and financial concepts of investment are related to each other; because, investment is a part of the savings of individuals; which flow into the capital market either directly or through institutions. Thus, investment decisions and financial decisions interact with each other. Also, Financial decisions are primarily concerned with the sources of money whereas investment decisions are traditionally concerned with the uses or budgeting of money.

    Wise investing requires knowledge of key financial concepts and an understanding of your personal investment profile and how these work together to impact investing decisions. Here we will understand the difference between saving and investing. Illustrate the risk/rate-of-return tradeoff, the importance of the time value of money and asset allocation; your personal risk tolerance, recognize your financial goals, and in defining an appropriate investment plan and asset mix for you and your family

    The Difference Between Saving and Investing:

    Even though the words “saving” and “investing” are often used interchangeably, there are differences between the two.

    Saving provides funds for emergencies and for making specific purchases in the relatively near future (usually three years or less). Also, the Safety of the principal and liquidity of the funds (ease of converting to cash) are important aspects of savings Rupees. Because of these characteristics, savings Rupees generally yield a low rate of return and do not maintain purchasing power.

    Investing, on the other hand, focuses on increasing net worth and achieving long-term financial goals. Investing involves risk (of loss of principal) and is to consider only after you have adequate savings.

    Savings v/s Investment Rupees
    SavingsInvestment
    SafeInvolve risk
    Easily accessibleVolatile in short time periods
    Low returnOffer potential appreciation
    Used for short-term goalsFor mid- & long-term goals
    What is the Concept of Investment - ilearnlot
    What is the Concept of Investment? Saving and Investing,
  • What is Foreign Exchange Market or Forex Market?

    What is Foreign Exchange Market or Forex Market?

    A Foreign exchange market or Forex market is a market in which currencies are bought and sold. It is to distinguish from a financial market where currencies borrow and lent. This market determines the foreign exchange rate. It includes all aspects of buying, selling, and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market. Also learned, Goods and Services Tax, What is Foreign Exchange Market or Forex Market?

    Learn and Study, What is Foreign Exchange Market or Forex Market?

    The foreign exchange market (Forex, FX, or currency market); a global decentralized or over-the-counter (OTC) market for the trading of currencies.

    Definition of Foreign Exchange Market:

    It is a market where the buyers and sellers involving in the sale; and, purchase of foreign currencies. In other words, a market where the currencies of different countries are bought and sold calls a foreign exchange market.

    The structure of the foreign exchange market constitutes central banks, commercial banks, brokers, exporters and importers, immigrants, investors, tourists. These are the main players of the foreign market, their position, and place shown in the figure below.

    At the bottom of a pyramid are the actual buyers; and, sellers of the foreign currencies- exporters, importers, tourists, investors, and immigrants. They are actual users of the currencies and approach commercial banks to buy them.

    The commercial banks are the second most important organ of the foreign exchange market. The banks dealing in foreign exchange play a role of “market makers”; in the sense that they quote daily the foreign exchange rates for buying and selling of foreign currencies. Also, they function as clearinghouses; thereby helping in wiping out the difference between the demand for and the supply of currencies. These banks buy currencies from the brokers and sell them to the buyers.

    Other things:

    The third layer of a pyramid constitutes the foreign exchange brokers. These brokers function as a link between the central bank and the commercial banks; and, also between the actual buyers and commercial banks. They are the major source of market information. These are the persons who do not themselves buy the foreign currency; but rather strike a deal between the buyer and the seller on a commission basis.

    The central bank of any country is the apex body in the organization of the exchange market. They work as the lender of the last resort and the custodian of foreign exchange of the country. Also, the central bank has the power to regulate and control the foreign exchange market to assure that it works in an orderly fashion. One of the major functions of the central bank is to prevent the aggressive fluctuations in the foreign exchange market, if necessary, by direct intervention. Intervention in the form of selling the currency when it overvalues and buying it when it tends to undervalue.

    General Features of Forex Market:

    They describe it as an OTC (Over the counter) market as there is no physical place where the participants meet to execute their deals. It is more an informal arrangement among the banks and brokers operating in a financing center purchasing and selling currencies, connected by telecommunications like telex, telephone, and a satellite communication network, SWIFT (Society for Worldwide Interbank Financial Telecommunication).

    The term foreign exchange market uses to refer to the wholesale segment of the market, where the dealings take place among the banks. Also, the retail segment refers to the dealings that take place between banks and their customers. Also, the retail segment refers to the dealings that take place between banks and their customers. The retail segment situates in a large number of places. They can consider not as foreign exchange markets, but as the counters of such markets.

    The leading foreign exchange market in India is Mumbai, Calcutta, Chennai, and Delhi is other center’s accounting for the bulk of the exchange dealings in India. The policy of the Reserve Bank has been to decentralize exchange operations and develop broader-based exchange markets. As a result of the efforts of Reserve Bank Cochin, Bangalore, Ahmadabad, and Goa have emerged as the new center of the foreign exchange market.

    Size of the Market:

    It is the largest financial market with a daily turnover of over USD 2 trillion. Also, Foreign exchange markets were primarily developed to facilitate the settlement of debts arising out of international trade. But these markets have developed on their own so much so that a turnover of about 3 days in the foreign exchange market is equivalent to the magnitude of world trade in goods and services.

    The largest foreign exchange market in London was followed by New York, Tokyo, Zurich, and Frankfurt. As well as, the business in foreign exchange markets in India has shown a steady increase as a consequence of the increase in the volume of foreign trade of the country, improvement in the communications systems, and greater access to the international exchange markets. Still, the volume of transactions in these markets amounting to about USD 2 billion per day does not compete favorably with any well developed foreign exchange market of international repute.

    The reasons are not far to seek. Also, the rupee is not an internationally traded currency and is not in great demand. Much of the external trade of the country designated in leading currencies of the world, Viz., US dollar, pound sterling, Euro, Japanese yen, and Swiss franc. Incidentally, these are the currencies that trade actively in the foreign exchange market in India.

    24 Hours Market:

    The markets are situated throughout the different time zones of the globe in such a way that when one market is closing the other is beginning its operations. Thus at any point in time one market or the other is open. Therefore, it states that the foreign exchange market is functioning 24 hours of the day.

    However, a specific market will function only during business hours. Some of the banks having the international network and having centralized control of funds management may keep their foreign exchange department in the key center open throughout to keep up with developments at other centers during their normal working hours. In India, the market is open for the time the banks are open for their regular banking business. No transactions take place on Saturdays.

    Efficiency:

    Developments in communication have largely contributed to the efficiency of the market. Also, the participants keep abreast of current happenings by access to such services as Dow Jones Telerate and Teuter.

    Any significant development in any market is almost instantaneously received by the other market situated at a far off place and thus has a global impact. This makes the foreign exchange market very efficient as if the functions under one roof.

    Currencies Traded in Forex Markets:

    In most markets, the US dollar is the vehicle currency, Viz., the currency used to denominate international transactions. This is even though with currencies like the Euro and Yen gaining a larger share, the share of the US dollar in the total turnover is shrinking.

    Physical Markets:

    In few centers like Paris and Brussels, foreign exchange business takes place at a fixed place, such as the local stock exchange buildings. At these physical markets, the banks meet and in the presence of the representative of the central bank and based on bargains, fix rates for several major currencies. This practice calls fixing.

    The rates thus fixed uses to execute customer orders previously placed with the banks. An advantage claimed for this procedure is that the exchange rate for commercial transactions will market-determine, not influence by any one bank. However, it observes that the large banks attending such meetings with large commercial orders backing up, tend to influence the rates.

    What is Foreign Exchange Market or Forex Market - ilearnlot
    What is Foreign Exchange Market or Forex Market?