UNIT 1

Meaning of Stock Exchange

A stock exchange is an important factor in the capital market. It is a secure place where trading is
done in a systematic way. Here, the securities are bought and sold as per well-structured rules
and regulations. Securities mentioned here include debenture and share issued by a public
company that is correctly listed at the stock exchange, debenture and bonds issued by the
government bodies, municipal and public bodies.

Typically bonds are traded Over-the-Counter (OTC), but a few corporate bonds are sold in a
stock exchange. It can enforce rules and regulation on the brokers and firms that are enrolled
with them. In other words, a stock exchange is a forum where securities like bonds and stocks
are purchased and traded. This can be both an online trading platform and offline (physical
location).

Functions of Stock Exchange

Following are some of the most important functions that are performed by stock exchange:

1. Role of an Economic Barometer: Stock exchange serves as an economic barometer

that is indicative of the state of the economy. It records all the major and minor changes
in the share prices. It is rightly said to be the pulse of the economy, which reflects the
state of the economy.
2. Valuation of Securities: Stock market helps in the valuation of securities based on the
factors of supply and demand. The securities offered by companies that are profitable and
 growth-oriented tend to be valued higher. Valuation of securities helps creditors,
investors and government in performing their respective functions.
3. Transactional Safety: Transactional safety is ensured as the securities that are traded in
the stock exchange are listed, and the listing of securities is done after verifying the
company’s position. All companies listed have to adhere to the rules and regulations as
laid out by the governing body.
4. Contributor to Economic Growth: Stock exchange offers a platform for trading of
securities of the various companies. This process of trading involves continuous
disinvestment and reinvestment, which offers opportunities for capital formation and
subsequently, growth of the economy.
5. Making the public aware of equity investment: Stock exchange helps in providing
information about investing in equity markets and by rolling out new issues to encourage
people to invest in securities.
6. Offers scope for speculation: By permitting healthy speculation of the traded securities,
the stock exchange ensures demand and supply of securities and liquidity.
7. Facilitates liquidity: The most important role of the stock exchange is in ensuring a
ready platform for the sale and purchase of securities. This gives investors the confidence
that the existing investments can be converted into cash, or in other words, stock
exchange offers liquidity in terms of investment.
8. Better Capital Allocation: Profit-making companies will have their shares traded
actively, and so such companies are able to raise fresh capital from the equity market.
Stock market helps in better allocation of capital for the investors so that maximum profit
can be earned.
9. Encourages investment and savings: Stock market serves as an important source of
investment in various securities which offer greater returns. Investing in the stock market
makes for a better investment option than gold and silver.

Features of Stock Exchange:

 A market for securities- It is a wholesome market where securities of government,

corporate companies, semi-government companies are bought and sold.
 Second-hand securities- It associates with bonds, shares that have already been
announced by the company once previously.
 Regulate trade in securities- The exchange does not sell and buy bonds and shares on
its own account. The broker or exchange members do the trade on the company’s behalf.
 Dealings only in registered securities- Only listed securities recorded in the exchange
office can be traded.
 Transaction- Only through authorised brokers and members the transaction for securities
can be made.
 Recognition- It requires to be recognised by the central government.
 Measuring device- It develops and indicates the growth and security of a business in the
index of a stock exchange.
  Operates as per rules– All the security dealings at the stock exchange are controlled by
exchange rules and regulations and SEBI guidelines.

Securities are financial instruments issued to raise funds. The primary function of the securities
markets is to enable to flow of capital from those that have it to those that need it. Securities
market help in transfer of resources from those with idle resources to others who have a
productive need for them. Securities markets provide channels for allocation of savings to
investments and thereby decouple these two activities. As a result, the savers and investors are
not constrained by their individual abilities, but by the economy’s abilities to invest and save
respectively, which inevitably enhances savings and investment in the economy.

Return refers to the benefit the investor will receive from investing in the security. Risk refers to
the possibility that the expected returns may not materialize. For example, a company may seek
capital from an investor by issuing a bond. A bond is a debt security, which means it represents a
borrowing of the company. The security will be issued for a specific period, at the end of which
the amount borrowed will be repaid to the investor. The return will be in the form of interest,
paid periodically to the investor, at a rate and frequency specified in the security. The risk is that
the company may fall into bad times and default on the payment of interest or return of principal.

SEBI – Securities and Exchange Board of India

Meaning / Definition

 SEBI stands for Securities and Exchange Board of India.

 It is the regulatory authority of the securities and capital markets in India.
 It works as a watchdog to protect investors, regulate intermediaries, and ensure the fair
functioning of stock markets.
 Established in 1988, given statutory status under the SEBI Act, 1992.
 Head Office: Mumbai (Bandra-Kurla Complex).
 Regional Offices: Delhi, Chennai, Kolkata, Ahmedabad.

Objectives

1. Protect the interests of investors.

2. Regulate and supervise the securities market.
3. Promote and develop the market in a transparent and fair manner.

Functions of SEBI

1. Protective Functions

 Prevents insider trading and fraudulent practices.

 Ensures fair disclosures in IPOs and corporate actions.
 Promotes investor awareness and redressal of grievances.
 2. Regulatory Functions

 Regulates stock exchanges, brokers, sub-brokers.

 Oversees mutual funds, portfolio managers, venture capital funds.
 Approves mergers, acquisitions, and takeovers.

3. Development Functions

 Encourages use of technology in trading (electronic trading, demat).

 Promotes fair practices and corporate governance.
 Conducts training programs for intermediaries.
 Runs SCORES platform for investor complaints.

Structure

 Chairperson – appointed by Government of India.

 2 Members – from Ministry of Finance.
 1 Member – from RBI.
 5 Members – nominated by Government (at least 3 full-time).

Current Leadership (2025)

 Chairperson: Tuhin Kanta Pandey (appointed March 1, 2025).

 He is a 1987 batch IAS officer (Odisha cadre).
 Previously served as Secretary, Department of Investment and Public Asset
Management (DIPAM), Ministry of Finance.
 Known for leading India’s disinvestment and privatization program, including major
PSU stake sales and IPOs.
 Brings expertise in finance, capital markets, and policy-making, expected to
strengthen SEBI’s role in PSU reforms, IPO regulation, and investor protection.
 He succeeded Madhabi Puri Buch (2022–2025), who was the first woman
Chairperson of SEBI.

Term Description

Sensex Sensex is a collection of the top 30 stocks listed on the BSE by way of market capitalisation.

SEBI The securities and Exchange Board of India (Sebi) is the securities market regulator to oversee any
fraudulent transactions and activities made by any of the parties: companies, investors, traders, brokers
 and the like.

Demat Demat, or dematerialised account, is a form of an online portfolio that holds a customer’s shares and
other securities in an electronic (dematerialised) format.

Trading It is the process of buying or selling shares in a company.

Stock Index A stock index or stock market index is a statistical source that measures financial market fluctuations.
They are performance indicators that indicate the performance of a certain market segment or the market
as a whole.

Portfolio It is a collection of a wide range of assets that are owned by investors. A portfolio can also include
valuables ranging from gold, stocks, funds, derivatives, property, cash equivalents, bonds, etc.

Bull Market In a bull market, companies tend to generate more revenue, and as the economy grows, consumers are
more likely to spend.

Bear Market Bear markets refer to a slowdown in the economy, which may make consumers less likely to spend and,
in turn, lower the GDP.

Nifty50 Nifty 50 is a collection of the top 50 companies listed on the National Stock Exchange (NSE).

Stock Market A stock broker is an investment advisor who executes transactions such as the buying and selling of
Broker stocks on behalf of their clients.

Bid Price The bid price is the highest price a buyer will pay to buy a specified number of shares of a stock at any
given time.

Ask Price The ask price in the stock market refers to the lowest price at which a seller will sell the stock.

IPO Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is the largest
 source of funds with long or indefinite maturity for the company.

Equity Equity is the value that would be received by the shareholder if all of the company’s assets were
liquidated and all of the company's debts were paid off.

Dividend A dividend refers to cash or reward that a company provides to its shareholders. It can be issued in
various forms, such as cash payment, stocks or any other form.

BSE Bombay Stock Exchange (BSE) is the largest and first securities exchange market in India. It was
established in 1875 as the Native Share and Stock Brokers' Association. It is also the first stock
exchange in India and provides an equities trading platform for small-and-medium enterprises.

NSE National Stock Exchange was the first to implement screen-based or electronic trading in India. It is the
fourth largest stock exchange in the world in terms of equity trading volume, as per the World
Federation of Exchanges (WFE).

Call & Put The call option gives the investor the right to purchase the underlying security, while the put option
Option gives the investor the right to sell shares of the underlying security. Both opinions let the investors profit
from movements in a stock's price.

Types of There are 2 types of stock markets:

Stock Market
 Primary Market: It creates securities and acts as a platform where firms float their new stock
options and bonds for the general public to acquire.

 Secondary Market: Here, investors trade in securities without involving the companies who
issued them in the first place with the help of brokers.

Ask and The term ‘ask’ in the stock market refers to the lowest price at which a seller will sell the stock. ‘Closing
Close price’ generally refers to the last price at which a stock trades during a regular trading session.
Moving It is a stock indicator commonly used for technical analysis to smoothen the price data by creating a
Average constantly updated average price. A rising moving average indicates that the security is in an uptrend,
while a declining moving average indicates a downtrend.

Primary Market

In a Primary Market, securities are created for the first time for investors to purchase. New
securities are issued in this market through a stock exchange, enabling the government as well as
companies to raise capital.

For a transaction taking place in this market, there are three entities involved. It would include a
company, investors, and an underwriter. A company issues security in a primary market as
an initial public offering (IPO), and the sale price of such a new issue is determined by a
concerned underwriter, which may or may not be a financial institution.

An underwriter also facilitates and monitors the new issue offering. Investors purchase the newly
issued securities in the primary market. Such a market is regulated by the Securities and
Exchange Board of India (SEBI).

The entity which issues securities may be looking to expand its operations, fund other business
targets or increase its physical presence among others. Primary market example of securities
issued include notes, bills, government bonds or corporate bonds as well as stocks of companies.

Functions of Primary Market

The functions of such a market are manifold –

 New Issue Offer

The primary market organises offer of a new issue which had not been traded on any other
exchange earlier. Due to this reason, it is also called a New Issue Market.

Organising new issue offers involves a detailed assessment of project viability, among other
factors. The financial arrangements for the purpose include considerations of promoters’
equity, liquidity ratio, debt-equity ratio and requirement of foreign exchange.

 Underwriting Services

Underwriting is an essential aspect while offering a new issue. An underwriter’s role in a

primary marketplace includes purchasing unsold shares if it cannot manage to sell the required
number of shares to the public. A financial institution may act as an underwriter, earning a
commission on underwriting.

Investors rely on underwriters for determining whether undertaking the risk would be worth its
returns. It may so happen that an underwriter ends up buying all the IPO issue, and subsequently
selling it to investors.

 Distribution of New Issue

A new issue is also distributed in a primary marketing sphere. Such distribution is initiated with
a new prospectus issue. It invites the public at large to buy a new issue and provides detailed
information on the company, issue, and involved underwriters.

Types of Primary Market Issuance

After the issuance of securities, investors can purchase such securities in various ways. There are
5 types of primary market issues.

 Public Issue
Public issue is the most common method of issuing securities of a company to the public at large.
It is mainly done via Initial Public Offering (IPO) resulting in companies raising funds from the
capital market. These securities are listed in the stock exchanges for trading.

A privately held company converts into a publicly-traded company when its shares are offered to
the public initially through IPO. Such a public offer allows a company to raise funds for
expansion of business, improving infrastructure, and repaying its debts, among others.

Trading in an open market also increases a company’s liquidity and provides a scope for
issuance of more shares in raising further capital for business.

The Securities and Exchange Board of India is the regulatory body that monitors IPO. As per its
guidelines, a requisite due enquiry is conducted for a company’s authenticity, and the company is
required to mention its necessary details in the prospectus for a public issue.

Advantages of Primary Market

 Companies can raise capital at relatively low cost, and the securities so issued in the
primary market provide high liquidity as the same can be sold in the secondary market
almost immediately.

 The primary market is an important source for mobilisation of savings in an economy.

Funds are mobilised from commoners for investing in other channels. It leads to
monetary resources being put into investment options.

 The chances of price manipulation in the primary market are considerably less when
compared to the secondary market. Such manipulation usually occurs by deflating or
inflating a security price, thereby deliberately interfering with fair and free operations of
the market.
  The primary market acts as a potential avenue for diversification to cut down on risk. It
enables an investor to allocate his/her investment across different categories involving
multiple financial instruments and industries.

 It is not subject to any market fluctuations. The prices of stocks are determined before an
initial public offering, and investors know the actual amount they will have to invest.

Disadvantages of Primary Market

 There may be limited information for an investor to access before investment in an IPO
since unlisted companies do not fall under the purview of regulatory and disclosure
requirements of the Securities and Exchange Board of India.

 Each stock is exposed to varying degrees of risk, but there is no historical trading data in
a primary market for analysing IPO shares because the company is offering its shares to
the public for the first time through an initial public offering.

 In some cases, it may not be favorable for small investors. If a share is oversubscribed,
small investors may not receive share allocation.

With this information regarding the primary market, individuals can make a well-thought-out
decision regarding investment in the market. It also makes way for the creation of an investment
portfolio with diversified risk.

Primary Market vs Secondary Market

Below are the primary distinctions between the Primary Market and the Secondary Market:
 Features Primary Market Secondary Market

Purpose First-time issuance and sale of new Securities that already exist are acquired
securities and sold

Participants Issuing Companies, Underwriters, Investors, Brokers, Dealers

Investors

Function Capital Raising Trading

Price Fixed Price Market-Driven Price

Volume Low Volume High Volume

Liquidity Low Liquidity High Liquidity

Regulation Regulated by SEBI Regulated by Stock Exchanges and

SEBI

Introduction

The capital market is a system that deals with raising and investing long-term funds. It is broadly
divided into two parts – the Primary Market (New Issue Market) and the Secondary Market
(Stock Exchange). The New Issue Market is the segment of the capital market where
companies raise funds by issuing new securities to investors for the first time. Since these
securities are freshly issued, they are called new issues.

Unlike the secondary market, where investors buy and sell existing securities among themselves,
the new issue market involves a direct relationship between companies (borrowers of funds)
and investors (lenders of funds). It is, therefore, an essential channel for converting savings
into capital formation and plays a vital role in economic development.

Meaning of New Issue

A new issue means the offering of securities by a company to investors to mobilize funds. These
securities can be in the form of equity shares, preference shares, debentures, bonds, or hybrid
financial instruments. The process takes place in the primary market. After allotment, the
securities are listed on a stock exchange and become available for trading in the secondary
market.

📌 Example: When LIC of India launched its IPO in 2022, it issued shares to the public for the
first time. That issue belonged to the new issue market. Later, when LIC shares started trading on
NSE and BSE, they belonged to the secondary market.

Objectives of New Issue Market

1. To Raise Long-term Funds: Companies obtain permanent capital for financing new
projects, diversification, and modernization.
2. Mobilization of Savings: It channels household and institutional savings into productive
investments.
3. Capital Formation: Promotes industrialization and economic development by creating
assets.
4. Wealth Distribution: Provides the general public with opportunities to become part-
owners of business organizations.
5. Employment Generation: New projects financed through the new issue market lead to
direct and indirect employment.
6. Strengthening Promoters and Strategic Investors: Through preferential allotments and
rights issues, promoters can maintain or enhance their holdings.

Methods of Raising Capital in New Issue Market

1. Public Issue
o A company issues securities directly to the general public through a prospectus.
o Initial Public Offering (IPO): First issue by an unlisted company to get listed on
a stock exchange.
o Follow-on Public Offer (FPO): When a listed company issues further shares.
o Example: The IPO of Zomato Ltd. (2021) was a public issue.
2. Rights Issue
o Additional shares offered to existing shareholders in proportion to their current
shareholding, usually at a concessional price.
o Maintains ownership balance and rewards loyal shareholders.
o Example: Reliance Industries raised funds through rights issues during the
pandemic.
3. Private Placement
o Securities are sold to a small, selected group of investors such as banks, mutual
funds, insurance companies, or high-net-worth individuals.
o Faster and less costly than public issues.
4. Preferential Allotment
o Securities issued to specific investors like promoters, venture capitalists, or
private equity funds at a fixed price.
o Used to bring in strategic investors or strengthen promoter holding.
5. Offer for Sale
 o Securities are issued first to intermediaries (merchant bankers or brokers) who
later sell them to the public.
o Common in government disinvestment of Public Sector Undertakings (PSUs).

Participants in the New Issue Market

1. Issuing Companies – Corporates raising funds.

2. Investors – Retail investors, institutional investors, domestic and foreign investors.
3. Intermediaries –
o Merchant Bankers/Lead Managers: Manage the issue and marketing.
o Underwriters: Guarantee subscription of securities.
o Registrars & Transfer Agents: Handle applications, allotments, and refunds.
o Bankers to the Issue: Collect application money.
4. Regulator (SEBI in India): Approves the draft prospectus, regulates the issue process,
ensures transparency, and protects investor interests.

Process of a New Issue

1. Decision by Company’s Board to raise funds.

2. Preparation of Prospectus or Draft Red Herring Prospectus (DRHP).
3. Filing with SEBI for scrutiny and approval.
4. Appointment of Intermediaries – merchant bankers, registrars, underwriters, and
bankers.
5. Pricing of Securities – through fixed price method or book-building.
6. Opening of Issue – investors apply through ASBA or UPI-enabled platforms.
7. Allotment of Securities – if oversubscribed, shares are allotted proportionately.
8. Listing on Stock Exchange – after allotment, shares start trading in the secondary
market.

Difference Between New Issue Market and Secondary Market

Basis New Issue Market (Primary) Secondary Market (Stock Exchange)

Deals with trading of existing

Meaning Deals with issue of new securities
securities

To provide liquidity and exit options to

Purpose To raise fresh capital for companies
investors

Determined by market forces (demand

Price Decided by company/underwriters
& supply)

Issuers, investors, merchant bankers, Buyers, sellers, brokers, stock

Participants
underwriters exchanges

Financing Mobilizes savings into investment No new capital raised, only ownership
Basis New Issue Market (Primary) Secondary Market (Stock Exchange)

Role transfer

Example IPO of LIC in 2022 Trading LIC shares on NSE/BSE

Introduction

Once securities are issued in the Primary Market (New Issue Market), they need a platform
where they can be bought and sold among investors. This platform is called the Secondary
Market, which operates through Stock Exchanges such as the NSE (National Stock
Exchange) and BSE (Bombay Stock Exchange) in India.

The process of buying and selling securities in the stock exchange is known as Trading of
Securities. It provides liquidity, price discovery, and investment opportunities for investors.

Meaning of Trading of Securities

 Trading of securities refers to the process of purchasing and selling of financial

instruments (equity shares, debentures, bonds, derivatives, mutual fund units, etc.)
through stock exchanges or other authorized platforms.
 It enables investors to enter and exit investments easily.
 Modern trading is screen-based and electronic, replacing the old open outcry system.

Objectives of Trading of Securities

1. Liquidity: Investors can convert securities into cash whenever required.

2. Price Discovery: Demand and supply of securities determine their market price.
3. Investor Participation: Provides opportunities for retail and institutional investors.
4. Safety of Transactions: Trading under SEBI-regulated stock exchanges ensures fairness.
5. Capital Mobilization: Encourages people to invest, as they know they can sell securities
anytime.

Process of Trading of Securities in Stock Exchange

Trading in India follows a T+1 rolling settlement cycle (trade day + 1 working day for
settlement).

Step 1: Opening a Demat and Trading Account

 Investors must open a Demat account (to hold securities electronically) and a Trading
account with a SEBI-registered stockbroker.
Step 2: Placing the Order

 Investor places a Buy or Sell order (quantity, price, type of order) through the broker’s
online platform.

Step 3: Order Matching

 Orders are sent to the stock exchange (NSE/BSE).

 The exchange’s electronic order matching system matches buy and sell orders based on
price-time priority.

Step 4: Trade Confirmation

 Once matched, the trade is confirmed. Both buyer and seller get a contract note from their
broker.

Step 5: Clearing and Settlement

 Clearing corporations (like NSCCL – National Securities Clearing Corporation Ltd.)

ensure that funds and securities are transferred correctly.
 T+1 cycle: If trade happens on Monday, settlement occurs on Tuesday.

Step 6: Transfer of Funds and Securities

 Buyer’s account is debited with money and credited with securities.

 Seller’s account is debited with securities and credited with money.

Types of Trading of Securities

1. Intraday Trading
o Buying and selling securities within the same trading day.
o No delivery, only profit/loss from price fluctuations.
2. Delivery Trading
o Securities purchased are held in the Demat account and can be sold later.
o Investors enjoy benefits like dividends, voting rights, and bonuses.
3. Derivatives Trading
o Trading in futures and options (F&O) based on underlying securities.
o Mostly used for speculation or hedging.
4. Margin Trading
o Investors trade using borrowed money from brokers to buy more than their
available capital.
5. Block and Bulk Deals
o Large trades executed between institutional investors, often reported separately by
exchanges.
Institutions Involved in Trading of Securities

 Stock Exchanges (NSE, BSE) – provide trading platform.

 Stock Brokers – registered intermediaries who facilitate buy/sell orders.
 Depositories (NSDL & CDSL) – hold securities electronically in demat form.
 Clearing Corporation (NSCCL, ICCL) – ensures clearing and settlement of trades.
 SEBI – regulator ensuring fair, transparent, and investor-protective trading.

Trading Mechanisms in India

(A) Screen-Based Trading System (SBTS)

 Introduced in 1990s, replacing open outcry system.

 Fully computerized, ensures transparency and efficiency.

(B) Order Driven Market

 All buy and sell orders are displayed on screen.

 Orders are matched automatically based on best price and time.

(C) Quote Driven Market

 Market makers/ dealers quote buy and sell prices.

 Less common in India compared to order-driven system.

Example of Trading

 Suppose Mr. A wants to buy 100 shares of Infosys at ₹1,600 per share.
 Mr. B wants to sell 100 shares of Infosys at ₹1,600.
 Through NSE’s order-matching system, the transaction takes place instantly.
 On T+1, Mr. A receives 100 Infosys shares in his Demat account, and Mr. B receives
₹1,60,000 in his bank account.

Recent Developments in Trading of Securities

 T+1 Settlement Cycle: Faster settlement introduced by SEBI.

 Online Mobile Trading Apps: Zerodha, Groww, Upstox, etc., increasing retail investor
participation.
 Algorithmic & High-Frequency Trading (HFT): Automated, computer-driven trading.
 Regulatory Framework: SEBI imposing circuit breakers, margin requirements, and
disclosure norms.
 International Participation: FPIs actively trading in Indian markets.

Advantages of Trading of Securities

 Provides liquidity and flexibility to investors.

  Helps in fair price discovery of securities.
 Ensures investor confidence through regulated platforms.
 Facilitates capital formation indirectly by encouraging primary market participation.

Limitations / Risks in Trading of Securities

 Price volatility may lead to investor losses.

 Risk of speculation and manipulation in markets.
 Requires awareness, technical knowledge, and continuous monitoring.
 Subject to regulatory and economic changes.
 UNIT 2
1. Portfolio Concept
📌 Definition:

A portfolio is a collection of different financial assets such as shares, bonds, mutual funds,
derivatives, real estate, and other securities held by an investor.

 It represents the total investment of an individual or institution.

 The aim is to achieve a balance between return (reward) and risk (uncertainty).

📌 Objectives of Portfolio:

1. Diversification of Risk – spreading investment across assets to reduce loss chances.

2. Capital Appreciation – ensuring long-term growth in wealth.
3. Income Generation – earning regular returns (dividends, interest).
4. Liquidity – ensuring funds can be withdrawn when needed.
5. Safety – protecting capital against high risk.

📌 Types of Portfolio:

1. Aggressive Portfolio
o Focus on growth stocks, volatile assets.
o High risk, high return.
2. Conservative Portfolio
o Focus on bonds, government securities, blue-chip stocks.
o Low risk, stable return.
3. Balanced Portfolio
o Mix of aggressive & conservative assets.
o Balances growth and stability.
4. Speculative Portfolio
o Includes high-risk securities (derivatives, penny stocks).
o Aimed at quick profit but very risky.
5. Socially Responsible Portfolio (SRP)
o Focuses on ethical or sustainable investments (ESG funds).

📌 Modern Portfolio Theory (MPT):

 Proposed by Harry Markowitz in 1952.

 Suggests that investors should maximize return for a given level of risk or minimize
risk for a given return.
  The key is to invest in assets with low or negative correlation to reduce portfolio risk.

2. Portfolio Return
📌 Meaning:

 Portfolio return is the total expected return from a portfolio.

 It is the weighted average of the returns of all securities in the portfolio.

📌 Features:

1. Portfolio return is additive – depends only on the weighted average.

2. It is not affected by correlation among assets.

3. Portfolio Risk
📌 Meaning:

 Portfolio risk is the uncertainty (volatility) of returns from the entire portfolio.
 Unlike return, risk is not just a weighted average – it depends on the interaction
between assets (correlation).

📌 Components of Risk:

1. Systematic Risk (Market Risk):

o Affects the entire market (e.g., inflation, interest rates, global crisis).
o Cannot be diversified away.
o Examples: 2008 global financial crisis, COVID-19 market crash.
2. Unsystematic Risk (Specific Risk):
o Affects a specific company or sector.
o Can be reduced/eliminated through diversification.
o Examples: strike in a company, poor management decisions, product recall.

📌 Role of Correlation:

 If ρ = +1 (perfect positive) → No diversification benefit.

 If ρ = 0 (no correlation) → Risk is reduced significantly.
 If ρ = –1 (perfect negative) → Risk can be completely eliminated.

📌 Example of Diversification:

 Stock A has a return of 12% with risk (σ) = 8%.

 Stock B has a return of 8% with risk (σ) = 6%.
 If perfectly positively correlated → Portfolio risk remains high.
 If negatively correlated → Portfolio risk can be reduced drastically, even close to zero.
4. Relationship between Risk and Return
 Risk-Return Trade-off: Higher return generally requires higher risk.
 Investors choose portfolios depending on their risk appetite:
o Risk-averse investors → prefer low-risk, stable portfolios.
o Risk-seeking investor’s → prefer high-risk, high-return portfolios.

📌 Efficient Frontier:

 A curve showing the set of optimal portfolios offering maximum return for a given risk
level.
 Portfolios below the frontier are inefficient.
 Portfolios on the frontier are considered efficient.

5. Practical Applications
1. Mutual Funds: Managed as portfolios of stocks/bonds to optimize risk-return.
2. Pension Funds: Mix of safe bonds and growth stocks for long-term stability.
3. Individual Investors: Construct portfolios based on risk tolerance, goals, and time
horizon.
4. Corporate Finance: Firms also diversify their investments and projects.

6. Summary Chart
Portfolio Portfolio
Aspect Portfolio Risk
Concept Return

Weighted
Combination
average of
Definition of different Variability of portfolio returns
individual
assets
returns

Estimate
Reduce risk,
expected
Objective optimize Measure uncertainty of portfolio outcome
portfolio
return
performance

Main
Diversification No effect Reduces risk if correlation < 1
principle

Nature Strategy Additive Not additive

 Portfolio Portfolio
Aspect Portfolio Risk
Concept Return

Risk Achieved via Not

Achieved through negative/low correlations
Reduction diversification applicable

In Simple Terms:

 Portfolio Concept = Mixing assets for safety & growth.

 Portfolio Return = Weighted average of returns.
 Portfolio Risk = Depends on variances + correlations, diversification reduces it.

Capital Market Theory (CMT)

The Capital Market Theory is an extension of Markowitz's Modern Portfolio Theory (MPT).
While MPT explains how rational, risk-averse investors build optimal portfolios of risky assets,
CMT introduces a risk-free asset to the equation. This creates a new set of optimal portfolios on
what is known as the Capital Market Line (CML).
Key concepts

 Assumptions: To derive the Capital Market Line, CMT makes several assumptions about
the market and investor behavior:
o Investors are risk-averse, rational, and maximize their utility.
o Investors have homogeneous expectations regarding asset returns, variances, and
correlations.
o Capital markets are frictionless, meaning there are no transaction costs, taxes, or
restrictions on borrowing or lending.
o Investors have access to a risk-free asset and can borrow or lend at this rate.
o All assets are perfectly divisible and liquid.
o Markets are efficient, and investors are price takers.
 The market portfolio: Under these assumptions, all investors will hold the same
"optimal risky portfolio" in combination with the risk-free asset. This optimal portfolio
must be the market portfolio, a value-weighted portfolio of all risky assets.
 The Capital Market Line (CML): The CML is a graphical representation of the risk-
return trade-off for efficient portfolios.
o Its vertical axis is the expected return, and its horizontal axis is the portfolio's total
risk, measured by standard deviation.
o The CML starts at the risk-free rate on the y-axis and is tangent to the efficient
frontier of risky assets at the market portfolio.
o Portfolios on the CML are considered the most efficient because they offer the
highest expected return for any given level of total risk.

Capital Asset Pricing Model (CAPM)

The CAPM is a single-factor model derived from CMT that describes the relationship between
the systematic risk of an asset and its expected return.
Key concepts
  Systematic vs. unsystematic risk: CAPM divides an asset's total risk into two
components:
o Systematic risk (market risk): The risk that affects all assets in the market and
cannot be eliminated through diversification (e.g., inflation, interest rate changes).
o Unsystematic risk (firm-specific risk): The risk unique to a company or industry

Beta (βbeta 𝛽): In the CAPM, the measure of systematic risk is beta (βbeta𝛽), which
that can be eliminated through diversification.

quantifies an asset's volatility relative to the overall market.
o A beta of 1 indicates the asset's price moves with the market.
o A beta greater than 1 suggests higher volatility than the market.
o A beta less than 1 suggests lower volatility.
 The Security Market Line (SML): The SML is a graphical representation of the CAPM
equation, plotting an asset's expected return against its systematic risk (beta).
o It serves as a benchmark for evaluating whether an individual asset or portfolio is
fairly priced, underpriced (plotted above the SML), or overpriced (plotted below
the SML).

Critiques and limitations

 Unrealistic assumptions: Critics argue that CAPM's highly restrictive assumptions, such
as homogeneous expectations and frictionless markets, do not hold in the real world.
 Single-factor model: The model's reliance on a single factor (beta) has been challenged
by empirical evidence suggesting that other factors, like firm size and value, also
influence returns.
 Roll's critique: Richard Roll famously argued that the CAPM is not empirically testable
because the true market portfolio, which includes all assets, is unobservable.

Arbitrage Pricing Theory (APT)

Developed by Stephen Ross, APT is a multi-factor model that serves as an alternative to CAPM
by explaining asset returns based on multiple systematic risk factors.
Key concepts

 Multi-factor approach: APT posits that an asset's expected return is a linear function of
its sensitivity to various macroeconomic or theoretical factors. Common factors might
include inflation, interest rates, and industrial production growth.
 No arbitrage opportunities: The central assumption of APT is that a perfectly
diversified portfolio with no systematic risk should earn a zero-risk premium. The theory
holds that if arbitrage opportunities (risk-free profits from mispriced securities) arise,
rational investors will quickly exploit and eliminate them.
 Fewer assumptions: APT is less restrictive in its assumptions than CAPM. It does not
assume mean-variance investor behavior or require identification of the market portfolio.

Critiques and limitations

  Factor identification: A key limitation of APT is that it does not provide guidance on
the number or identity of the specific factors that determine asset returns. These factors
must be identified through empirical research.
 Practical complexity: While theoretically more robust, APT is more complex to
implement than CAPM. It requires determining the relevant factors and calculating each
asset's sensitivity (beta) to each of those factors.

Portfolio Management
Portfolio management is the theoretical framework for the systematic allocation and oversight of
assets to meet an investor's financial goals.
Modern Portfolio Theory (MPT)
The theoretical basis for modern portfolio management was pioneered by Harry Markowitz in
the 1950s.

 Core principle: MPT holds that investors can create diversified portfolios that maximize
expected return for a given level of risk. This is achieved by combining assets that are not
perfectly positively correlated.
 Efficient frontier: MPT's key contribution is the concept of the efficient frontier, a curve
on a graph representing the set of optimal portfolios that offer the highest possible
expected return for a given level of risk.
 Diversification: The theory quantifies how adding assets with low or negative correlation
can reduce portfolio risk without sacrificing expected returns.

Mutual Fund Theorem and Industry

The mutual fund industry is a practical application of many of these theoretical principles, most
notably Markowitz's diversification and the Mutual Fund Theorem.
Mutual Fund Theorem (Separation Principle)

 Concept: This principle, developed by James Tobin and Harry Markowitz, states that any
investor's optimal portfolio can be constructed by combining a single, optimal risky
portfolio (which, in theory, is the market portfolio) with a risk-free asset.
 Application: The theorem suggests that the investment decision can be separated into
two parts:
1. Determining the optimal mix of risky assets.
2. Deciding on the risk level by combining the optimal risky portfolio with a risk-
free asset, based on the investor's risk tolerance.

Mutual funds in practice

 Diversification: Mutual funds serve as a convenient and affordable vehicle for achieving
diversification. By purchasing a single fund, an investor can gain exposure to a wide
basket of securities.
 Professional management: Professional fund managers, in theory, apply these principles
to construct and manage the fund's portfolio on behalf of investors.
 Types: The wide array of fund types—equity, debt, hybrid, index funds—allows
investors to align their investments with their specific risk tolerance, time horizon, and
financial objectives.
 UNIT 3
I. DEVELOPMENT FINANCIAL INSTITUTIONS (DFIs)
Meaning:

Development Financial Institutions (DFIs) are specialized financial bodies that provide long-
term capital and development assistance to industries, agriculture, and infrastructure sectors.
Unlike commercial banks that focus on short-term working capital loans, DFIs primarily
promote industrial growth, regional balance, and entrepreneurship development.

Objectives of DFIs:

1. Promote balanced regional and sectoral development.

2. Provide long-term and project-based finance to industries.
3. Support modernization, diversification, and technological upgradation.
4. Encourage small and medium-scale enterprises (SMEs).
5. Support new entrepreneurs through project appraisal and guidance.
6. Supplement and coordinate the efforts of other financial institutions.
7. Promote industrial infrastructure such as industrial estates and parks.
8. Contribute to economic growth by mobilizing domestic and foreign capital.

1. Industrial Development Bank of India (IDBI)

Establishment and Evolution:

 Established in 1964 under the IDBI Act as a wholly owned subsidiary of the Reserve
Bank of India (RBI).
 Transferred to Government of India ownership in 1976.
 Converted into a commercial bank in 2004 (IDBI Bank Ltd.).

Objectives:

 Serve as an apex institution for coordinating activities of other DFIs.

 Provide direct and indirect financial assistance to industrial undertakings.
 Promote institutional infrastructure for industrial growth.
 Act as a catalyst in balanced and accelerated industrial development.

Functions:

1. Direct Financial Assistance:

o Project loans, underwriting, subscription to shares and debentures.
2. Refinance and Rediscounting:
o Refinancing loans extended by banks and financial institutions.
 3. Developmental Role:
o Promotion of entrepreneurship, technical consultancy, and training.
4. Coordination Role:
o Align the activities of institutions like IFCI, ICICI, and SFCs.
5. Soft Loans and Special Funds:
o Assistance for modernization and R&D activities.

Transformation:

 Post-2004, IDBI became a full-fledged universal bank, combining commercial banking

and development finance.
 IDBI’s role today includes retail banking, corporate lending, and infrastructure project
finance.

2. Industrial Credit and Investment Corporation of India

(ICICI)
Establishment:

 Formed in 1955 by the World Bank, Government of India, and Indian industry.
 Initially a private sector DFI aimed at developing industrial growth.

Objectives:

 Assist private sector industries in obtaining long-term finance.

 Promote private ownership and management of industrial enterprises.
 Encourage modernization and technological advancement in industry.
 Promote capital market development.

Functions:

1. Medium and Long-Term Loans: For setting up new industries and expansion.
2. Underwriting and Subscription: To new industrial securities.
3. Guarantee Services: For deferred payment and foreign currency loans.
4. Merchant Banking Services: Assisting in mergers, acquisitions, and capital raising.
5. Venture Capital and Project Consultancy.

Transformation:

 Merged with ICICI Bank in 2002, forming India’s first universal bank.
 Today, ICICI Bank offers diversified services – retail banking, investment banking, and
infrastructure financing.

3. Industrial Finance Corporation of India (IFCI)

Establishment:

 Created in 1948 under an Act of Parliament as India’s first DFI.

Objectives:

 Provide long-term credit to industrial enterprises.

 Assist in the establishment, expansion, and modernization of industries.
 Promote industrial growth in backward regions.

Functions:

1. Direct Assistance:
o Project finance, corporate loans, and working capital term loans.
2. Indirect Assistance:
o Refinancing, guarantees, and underwriting services.
3. Advisory Services:
o Consultancy, project preparation, and appraisal support.
4. Special Schemes:
o Venture capital, infrastructure, and energy projects.

Current Role:

 Reconstituted as a public sector NBFC under the Companies Act.

 Focuses on project financing for infrastructure, power, and real estate sectors.

4. National Bank for Agriculture and Rural Development

(NABARD)
Establishment:

 Established in 1982 by the NABARD Act, 1981, replacing the Agricultural Credit
Department of RBI and Agricultural Refinance and Development Corporation (ARDC).

Objectives:

 Promote sustainable agricultural and rural development.

 Provide refinance support to cooperative and rural banks.
 Foster financial inclusion and livelihood promotion in rural India.

Functions:

1. Refinance:
o Provides refinance to RRBs, cooperative banks, and other rural credit institutions.
2. Developmental:
 Promotes SHGs, Farmers Clubs, and rural enterprises.
o
3. Supervisory:
o Regulates and inspects cooperative banks and RRBs.
4. Promotional:
o Capacity building, skill development, and microfinance programs.
5. Rural Infrastructure Development Fund (RIDF):
o Finances rural roads, irrigation, and bridges through state governments.

Significance:

 NABARD is the apex institution for rural credit and agriculture financing, playing a key
role in financial inclusion and poverty alleviation.

5. Regional Rural Banks (RRBs)

Establishment:

 Formed under the RRB Act, 1976 on the recommendations of the Narasimham
Committee.

Objectives:

 Develop the rural economy by providing credit and financial services to the agriculture,
small-scale industries, artisans, and weaker sections.

Ownership Structure:

 Central Government – 50%

 State Government – 15%
 Sponsor Bank – 35%

Functions:

 Granting short and medium-term loans for agriculture, trade, and rural industries.
 Implementing government-sponsored schemes like PMEGP, MGNREGA, etc.
 Promoting rural savings and financial inclusion.

Reforms:

 Mergers and amalgamations have reduced the number of RRBs to around 43 (as of
recent updates) to enhance efficiency and profitability.

6. State Level Financial Institutions

A. State Financial Corporations (SFCs):

 Established under the State Financial Corporations Act, 1951.

 Objective: To provide medium and long-term finance to small and medium enterprises
(SMEs).
 Functions:
o Provide loans for purchase of fixed assets.
o Underwrite and guarantee loans.
o Offer seed capital and technical guidance.

B. State Industrial Development Corporations (SIDCs):

 Set up by State Governments to promote industrialization at the regional level.

 Activities:
o Develop industrial estates, parks, and clusters.
o Promote joint sector undertakings.
o Provide equity participation and project assistance.

II. NON-BANKING FINANCIAL COMPANIES (NBFCs)

Definition:

NBFCs are financial institutions that provide banking-type services but do not have a banking
license.
They are regulated under Chapter IIIB of the RBI Act, 1934.

Importance:

 Crucial for financial inclusion, credit expansion, and supporting MSMEs.

 Cater to sectors underserved by traditional banks.

Types of NBFCs (as per RBI classification):

1. Asset Finance Company (AFC) – Finances physical assets supporting economic activity
(vehicles, equipment).
2. Investment Company (IC) – Engages in the acquisition of securities for investment.
3. Loan Company (LC) – Provides loans and advances for various purposes.
4. Infrastructure Finance Company (IFC) – Provides loans to infrastructure projects.
5. Core Investment Company (CIC) – Holds shares of group companies.
6. Microfinance Institution (NBFC-MFI) – Provides small-ticket loans to low-income
groups.
7. NBFC-Factor – Engages in factoring receivables.
8. Housing Finance Company (HFC) – Provides housing loans.
Working:

 Raise funds through market borrowings, debentures, or term loans.

 Lend to individuals and businesses, focusing on specific sectors (e.g., housing, vehicles,
SMEs).
 Offer leasing, hire purchase, and investment advisory services.

Strategies for Commercial Viability:

1. Digital Transformation: Use AI, fintech, and mobile technology.

2. Diversified Portfolio: Spread risk across industries and products.
3. Customer-Centric Models: Tailor offerings for niche markets.
4. Efficient Risk Management: Strengthen asset-liability management (ALM).
5. Strategic Partnerships: Tie-ups with banks and fintechs.
6. Cost Rationalization: Reduce operational overheads through automation.
7. Compliance and Transparency: Adhere to RBI’s prudential norms.

III. INSURANCE ORGANIZATIONS IN INDIA

Overview:

Insurance organizations provide risk coverage and financial protection against unforeseen
events.
They mobilize long-term savings and channel them into productive investments.

Regulatory Body:

 Insurance Regulatory and Development Authority of India (IRDAI), established

under the IRDA Act, 1999.

Classification:

1. Life Insurance Companies

o Provide life, annuity, and pension products.
o Example: LIC, HDFC Life, SBI Life, ICICI Prudential.
2. General Insurance Companies
o Provide insurance for health, motor, fire, and marine risks.
o Example: New India Assurance, ICICI Lombard, Bajaj Allianz.
3. Reinsurance Companies
o Provide insurance to other insurance companies.
o Example: General Insurance Corporation of India (GIC Re).

Working Mechanism:

1. Risk Pooling: Collect premiums from policyholders.

 2. Investment of Funds: Invest in bonds, equities, and infrastructure.
3. Claim Settlement: Compensate policyholders as per policy terms.
4. Underwriting and Risk Assessment: Evaluate and price risk accurately.
5. Distribution: Through agents, brokers, bancassurance, and digital platforms.

Strategies for Commercial Viability:

1. Product Innovation: Micro-insurance, health covers, and digital insurance products.

2. Technology Adoption: AI for underwriting, chatbots for claim handling.
3. Customer Relationship Management (CRM): Enhance trust and satisfaction.
4. Financial Discipline: Optimize investment portfolios and manage solvency margins.
5. Partnership Models: Bancassurance and collaboration with fintech startups.
6. Awareness and Penetration: Improve insurance literacy in rural areas.
7. Efficient Claim Management: Quick and transparent settlements to build credibility.

Conclusion
DFIs, NBFCs, and Insurance organizations together form the backbone of India’s financial
infrastructure.

 DFIs promote industrial and regional development.

 NBFCs enhance financial inclusion and innovation.
 Insurance companies provide financial stability and social security.

Together, they ensure a diverse, resilient, and inclusive financial system capable of supporting
India’s economic growth.
 UNIT 4
I. Introduction
The leasing and hire purchase industry in India is an essential component of the financial
services sector, providing alternative financing methods for acquiring capital goods, consumer
durables, and vehicles.
These arrangements help businesses and individuals access assets without large upfront
investments, supporting growth in industrial and consumer markets.

Leasing and hire purchase are particularly significant in developing economies like India, where:

 Access to long-term finance is limited.

 Capital markets are underdeveloped for smaller firms.
 Rapid industrialization and modernization demand flexible financing.

II. Growth and Development of the Industry

Historical Background:

 The concept of leasing originated in the USA in the 1950s.

 In India, the first leasing company — First Leasing Company of India Ltd. — was
established in 1973 in Chennai by Farouk Irani.
 This was followed by Sundaram Finance, 20th Century Leasing, and
Cholamandalam Finance in the 1980s.
 In the 1990s, NBFCs and financial institutions entered the sector, expanding leasing and
hire purchase financing to automobiles, machinery, and office equipment.

Current Scenario:

 Leasing and hire purchase form a major component of NBFC activities.

 Used widely by corporate houses, SMEs, logistics, aviation, and construction sectors.
 Growth has been aided by digital lending platforms and flexible repayment models.
 The industry operates under the regulatory supervision of the Reserve Bank of India
(RBI).

Regulatory Framework:

1. RBI Guidelines for NBFCs (Non-Banking Financial Company - Lease and Hire
Purchase).
2. Accounting Standards:
o AS 19: Accounting for Leases.
o AS 25/IFRS 16: Lease recognition and treatment.
3. Legal Provisions:
 o Indian Contract Act, 1872
o Hire Purchase Act, 1972 (though not notified fully)
o Companies Act, 2013 (for corporate disclosures)

III. Leasing: Concept, Meaning, and Importance

Definition:

Leasing is a contractual agreement between two parties where the lessor (owner) allows the
lessee (user) to use an asset for a specified period in exchange for periodic payments called lease
rentals.

It represents asset-based financing, where:

 Ownership remains with the lessor.

 Usage rights are transferred to the lessee.
 Rentals serve as payment for the use of the asset.

Economic Importance:

 Provides alternative financing when loans are unavailable.

 Helps in tax planning through depreciation and rental deductions.
 Facilitates technological modernization.
 Encourages capital formation and promotes industrial expansion.

IV. Parties Involved in a Lease Transaction

1. Lessor:
o Legal owner of the asset.
o May be a bank, NBFC, or leasing company.
o Bears the residual risk in case of non-performance or obsolescence.
2. Lessee:
o The user of the asset who pays lease rentals.
o Has no ownership but enjoys the economic benefits of usage.
3. Supplier or Vendor:
o Manufacturer or seller of the asset delivered to the lessee.
4. Financier:
o Provides finance to the lessor in case of a leveraged lease.
5. Guarantor/Insurer:
o Provides protection against default or asset damage.

V. Evaluation of Lease Transaction

A lease transaction is evaluated on financial viability, tax efficiency, risk, and accounting
treatment.

A. Financial Evaluation

 Cost of Leasing vs Buying: Compare NPV of lease payments with loan EMI or outright
purchase.
 Tax Shield: Lease rentals are deductible expenses for lessee.
 Depreciation Benefit: Lessor claims depreciation benefits under the Income Tax Act.
 Residual Value: Estimate asset value after lease expiry.

B. Risk Evaluation

 Default risk, obsolescence risk, and maintenance responsibilities are assessed before
contract execution.

C. Accounting Treatment

 AS 19 / IFRS 16 require recognition of finance leases as both assets and liabilities in the
lessee’s books.
 Operating leases are shown as revenue expenses.

VI. Types of Leases and Implications

1. Operating Lease

 Short-term, cancellable, and covers less than the asset’s economic life.
 Lessor provides maintenance.
 Example: Leasing of photocopiers or computers.
 Implication: Rental expense deductible; asset remains on lessor’s books.

2. Financial (Capital) Lease

 Long-term, non-cancellable, and covers the full cost of the asset.

 Lessee bears maintenance and insurance costs.
 Implication: Treated like a loan; both asset and liability shown in lessee’s balance sheet.

3. Sale and Leaseback

 The lessee sells an owned asset to the lessor and leases it back.
 Implication: Improves liquidity while retaining asset use.

4. Leveraged Lease

 The lessor borrows part of the asset cost from lenders, pledging lease rentals as security.
  Common in infrastructure and aircraft leasing.

5. Cross-Border Lease

 Lessor and lessee located in different countries.

 Implication: Subject to double taxation treaties and exchange regulations.

6. Wet Lease / Service Lease

 Lessor provides asset along with operational support (crew, maintenance).

 Common in aviation and shipping industries.

7. Synthetic / Structured Lease

 Combines features of both operating and finance leases to maximize tax and accounting
benefits.

VII. Advantages and Disadvantages of Leasing

Advantages:

 No large upfront capital.

 Flexible repayment schedules.
 Tax benefits for lessee and lessor.
 Off-balance sheet financing (operating leases).
 Hedge against inflation and obsolescence.

Disadvantages:

 Overall cost may be higher than ownership.

 Lessee has no ownership rights.
 Non-cancellable leases can be restrictive.
 Complicated accounting and tax treatment.

VIII. Hire Purchase: Concept and Scope

Meaning:

Under a hire purchase agreement, the hirer takes possession of an asset immediately but
ownership transfers only after payment of all installments.

Legal Nature:

 Governed by the Hire Purchase Act, 1972 (not fully enforced) and Indian Contract
Act, 1872.
  It is both a contract of bailment and a contract of sale upon completion of payment.

Features:

 Down payment + series of equal installments.

 Each installment has a principal and interest component.
 Hirer can terminate agreement any time by returning the goods.
 Ownership passes only on the last payment.

Scope:

 Commonly used for automobiles, agricultural machinery, household appliances, and

office equipment.
 Important source of consumer credit in India.

IX. Differences Between Lease and Hire Purchase

Basis Leasing Hire Purchase

Nature Contract of use Contract of sale

Ownership Retained by lessor Transfers to hirer after final payment

Possession With lessee With hirer

Risk of Loss Lies with lessee (in finance lease) Lies with hirer

Depreciation Claim Claimed by lessor Claimed by hirer after ownership

Tax Treatment Lease rentals are deductible Only interest is deductible

Balance Sheet Asset not shown (in operating lease) Asset & liability recorded

Termination As per lease terms Hirer may terminate before ownership

Suitable For Business equipment, industrial machinery Consumer goods, vehicles

Implications for Business:

 Leasing suits businesses avoiding ownership risks or seeking flexibility.

 Hire Purchase suits consumers or firms wanting ownership after usage.
 Both methods enhance liquidity and capital efficiency.
💳 Consumer Credit and Plastic Money

I. Consumer Credit
Definition:

Consumer Credit refers to credit extended to individuals to buy goods and services that they
pay for in the future.
It enhances purchasing power, promoting consumption and economic growth.

Types of Consumer Credit:

1. Installment Credit: Fixed payments over time (e.g., cars, furniture).

2. Revolving Credit: Flexible limit renewed monthly (e.g., credit cards).
3. Non-Installment Credit: Short-term (e.g., utility bills).
4. Retail Credit: Retailers offering goods on deferred payment.
5. Cash Credit: Personal loans and overdraft facilities.

Institutions Providing Consumer Credit:

 Commercial Banks
 NBFCs
 Cooperative Credit Societies
 Retail Chains (like Bajaj Finance, HDFC Consumer Loans)

Advantages:

 Boosts consumer spending and demand.

 Supports retail and service sector growth.
 Encourages living standard improvements.
 Builds credit history.

Disadvantages:

 Overdependence on credit leading to indebtedness.

 High-interest rates on delayed payments.
 Encourages impulsive buying behavior.

II. Plastic Money

Definition:

Plastic money is a term used for plastic cards used as substitutes for cash transactions.
It ensures cashless, convenient, and secure payments in both physical and digital
environments.

Evolution in India:

 Introduced in 1980s by foreign banks (Visa, MasterCard).

 Expanded after liberalization in 1991.
 Government initiatives like Digital India, RuPay cards, and UPI integration have
accelerated usage.

III. Types of Plastic Money

Type Description Examples Key Feature

Credit Card Allows spending on credit; repay later SBI, ICICI, HDFC cards Revolving credit limit

Linked to bank account; immediate Direct payment from

Debit Card Visa, RuPay debit cards
debit account

Charge Card Entire bill must be cleared monthly Amex Charge Card No preset limit, no rollover

Usage limited to loaded

Prepaid Card Preloaded value for limited use Gift cards, travel cards
value

Stores user data

Smart Card Chip-based multipurpose card Metro, toll cards
electronically

Issued via apps or

Virtual Card Digital-only card for online payments Enhanced security
banks

IV. Working Mechanism

1. Card Issuance: Bank issues card to verified customer.
2. Transaction: Customer uses card at merchant or online platform.
3. Authorization: Card network (Visa, MasterCard, RuPay) authenticates details.
4. Clearing and Settlement: Funds are transferred electronically.
5. Billing: Credit cardholders receive monthly statements with grace period for repayment.

V. Advantages of Plastic Money

  Convenience and safety (no need to carry cash).
 Global acceptance and online compatibility.
 Record keeping for personal finance management.
 Loyalty points, cashback, and travel benefits.
 Encourages digital economy and transparency.

Challenges:

 Cyber frauds, data theft, phishing.

 Overspending and high-interest charges.
 Dependence on technology infrastructure.
 Security concerns in rural areas.

VI. Relationship Between Consumer Credit and Plastic

Money
Aspect Consumer Credit Plastic Money

Financial facility allowing deferred

Nature Physical or virtual instrument for transactions
payment

Example EMI finance, personal loans Credit, debit, or prepaid cards

Function Enhances purchasing power Facilitates payment convenience

Provider Banks, NBFCs, retailers Banks and payment networks

Economic Role Stimulates demand and consumption Promotes cashless economy

VII. Global and Indian Perspective

 Globally, leasing contributes 20–25% of total capital formation, with major markets in
the USA, UK, Japan, and China.
 In India, leasing and hire purchase finance are major components of NBFC credit
portfolios, contributing to MSME and infrastructure finance.
 Consumer credit and plastic money have revolutionized retail finance — India ranks
among the top five countries globally in digital payments volume.

UNIT 5
1. Concept of a Mutual Fund

A mutual fund is a pooled investment vehicle that collects money from a large number of
investors and invests that corpus in a diversified portfolio of securities (equity, debt, money-
market instruments, etc.) managed by a professional Asset Management Company (AMC). The
investors receive units of the fund in proportion to their investment, and the value of these units
fluctuates with the market value of the underlying securities. The primary economic rationale is
economies of scale: small investors get access to professional portfolio management,
diversification, liquidity and products that would be difficult or expensive to obtain individually
(for example, a diversified portfolio of 30–50 stocks or a basket of corporate bonds). Mutual
funds, therefore, act as intermediaries between retail/ institutional investors and the capital
markets, channeling household savings into productive assets while offering risk-return profiles
suited to varied investor objectives.

Sub-points:
1.1 Pooled structure & pro rata ownership: Every investor owns units that represent a pro rata
share of the fund’s net assets; investors do not own the portfolio securities directly.
1.2 Professional management: AMCs employ fund managers, research analysts and risk teams
that make buy/sell decisions based on mandate, risk limits and investment strategy.
1.3 Regulatory wrapper & investor protection: Mutual funds operate under a regulatory
framework (in India under SEBI) which prescribes disclosure, valuation, audit, limits on related-
party transactions and investor grievance mechanisms to protect unit-holders.

2. Types of Mutual Funds (detailed classification and implications)

Mutual funds can be classified by structure, investment objective, maturity and distribution
policy. Each classification has distinct implications for liquidity, taxation, risk and suitability.

2.1 By Structure
a) Open-ended funds: Investors can buy or redeem units at NAV on any business day. These
funds provide high liquidity and are suited for investors needing flexibility.
b) Closed-ended funds: Have a fixed corpus and maturity; units are listed on exchanges and
traded like stocks. Liquidity depends on market demand; price can trade at a premium or
discount to NAV. Closed funds suit investors seeking a buy-and-hold with a defined investment
tenor.
c) Interval funds: Hybrid of open and closed; they allow redemptions only during predefined
windows.

2.2 By Investment Objective (major categories)

a) Equity Funds: Invest predominantly in equities. Subtypes include large-cap, mid-cap, small-
cap, multi-cap, sectoral/thematic funds, ELSS (tax-saving). Risk/return: highest volatility but
potential for long-term capital growth.
b) Debt Funds: Invest in fixed income — government securities, corporate bonds, money-
market instruments. Subtypes: liquid, ultra-short, short-term, income funds, gilt funds, credit risk
funds. Lower volatility; interest rate and credit risks vary by subtype.
c) Hybrid Funds: Mix equity and debt to balance growth and stability — conservative hybrid,
balanced advantage, dynamic asset allocation. Useful for asset allocation within a single product.
d) Index Funds & ETFs: Passive funds tracking an index; ETFs trade on exchanges intraday.
Offer low costs and tracking error considerations; suitable for cost-conscious investors.
e) Solution-oriented funds / Fund of Funds / PMS linked funds: Designed for specific goals
(retirement, children’s education) or that invest in other funds—useful but add layers of cost.

2.3 By Distribution Policy

Dividend (payout) plans: Periodic distributions of income/capital gains.
Growth/Accumulation plans: No payouts; returns reflected in NAV appreciation.
Dividend reinvestment plans: Dividends automatically reinvested into additional units.

Implications: choice of type determines tax treatment, liquidity, volatility and suitability for an
investor’s time horizon and objectives.

3. Significance of Mutual Funds (economic, investor-level and market-

level)

Mutual funds play several critical roles:

3.1 On the investor side

 Diversification & risk management: By spreading investments across many securities
and sectors, funds reduce idiosyncratic risk for small investors.
 Professional management & research access: Individual investors gain the benefit of
research, risk controls and active trading that would be costly to replicate.
 Affordability & liquidity: Small ticket sizes (SIP facilities) let investors start with
modest sums; open-ended funds provide easy redemptions.

3.2 On capital markets & economy

 Mobilization of savings into capital markets: Mutual funds channel household savings
into equities, corporate debt and government securities—supporting corporate financing
and market depth.
 Price discovery & market efficiency: Large, active funds contribute to liquidity,
narrower spreads and more efficient pricing.
  Stability & institutional investing: Long-term mutual fund flows can stabilize markets
and provide an institutional investor base.

3.3 On product innovation & financial inclusion

 Product variety & goal-based investing: Funds offer SIPs, systematic withdrawal plans
(SWPs), target maturity funds, ETFs and thematic funds—broadening choices for
different investor needs.
 Financial inclusion: Through distributor networks, platforms and direct plans, mutual
funds have expanded access to formal financial savings across geographies.

Implications: The growth of mutual funds enhances household participation in financial markets,
supports corporate financing needs, and strengthens the overall financial ecosystem.

4. Net Asset Value (NAV) — definition, calculation, components and

nuances

Definition & Role: NAV is the per-unit market value of a mutual fund scheme — it is the price
at which units are bought (for some schemes) and redeemed on any valuation day. NAV equals
the fund’s total assets minus liabilities, divided by outstanding units. NAV is updated at least
once every business day (end-of-day pricing).

Components explained:

 Market value of securities: Equity valued at closing market prices; bonds valued using
prevailing yields/price matrix.
 Accrued income: Unpaid interest, dividends receivable.
 Liabilities: Pending expenses, payables, brokerage, tax provisions.
 Outstanding units: Units issued minus units redeemed.

Nuances & practical points:

4.1 NAV vs. performance: NAV alone is not a performance metric—changes in NAV plus
distributed dividends/capital gains give total return. Investors must consider total return and risk-
adjusted returns (Sharpe ratio, alpha).
4.2 Expense ratio & impact: Operating costs (TER) are deducted from assets, reducing NAV;
lower expense ratios generally benefit long-term investor returns.
4.3 Loads & taxes vs NAV: Sales loads (entry) and exit loads do not change NAV but affect
effective cost to investor; taxation on distributions and capital gains affects net returns.
4.4 Pricing frequency: Open-ended schemes price transactions based on NAV declared after
market close (forward pricing), unlike equity stock prices which change intraday. SEBI Investor

5. Evolution & Growth of Mutual Funds

The mutual fund industry in India has evolved through distinct phases characterized by
institutional change, deregulation and increasing retail participation.

5.1 Historical phases (high level)

 Phase I (1963–1987): Creation of Unit Trust of India (UTI) in 1963; single dominant
public entity offering unit investment schemes.
 Phase II (1987–1993): Entry of public sector banks and financial institutions into fund
management; beginning of diversity.
 Phase III (1993–2003): Post-liberalization SEBI regulation and entry of private sector
AMCs; greater product innovation.
 Phase IV (2003–2013): Consolidation, retail distribution growth, introduction of ETFs
and online platforms.
 Phase V (2013–present): Rapid SIP adoption, significant retail participation,
digitization, rise of index funds/ETFs, thematic funds and huge growth in AUM. (For a
detailed timeline and phase definitions, see AMFI resources). AMFI India

5.2 Key regulatory & market milestones

 SEBI regulations (1996 and later): Brought AMCs under a strict regulatory framework
(disclosure, trustee structure, NAV valuation norms).
 Introduction of ETFs & index funds: Brought passive investing to India.
 SIPs & digital onboarding: Systematic Investment Plans and online KYC transformed
small-ticket, regular investing.
 Retailization & AUM growth: In recent years mutual funds have recorded record
inflows and AUM expansion, driven by SIPs, increased financial literacy and digital
platforms. For instance, industry AUM has reached record highs in the 2020s as
institutional and retail flows surged. Reuters

5.3 Contemporary trends and implications

 Shift from concentrated institutional holdings to retail SIPs — improves household
participation but can increase volatility around redemption behavior.
 Product proliferation (thematic, sectoral, arbitrage, liquid alternatives) — increases
choice but requires investor education on risks.
 Regulatory tightening (category rationalization, performance-based disclosures) — aims
to protect investors from mis-selling and improve transparency.
6. Registrar (Registrar & Transfer Agent — RTA) — role, responsibilities
and SEBI expectations

Core role: Registrar & Transfer Agents (RTAs), often appointed by AMCs, are the operational
backbone for unit-holder record keeping and transaction processing. They maintain the master
register of unit-holders, process applications for purchase/redemption/switch, handle
dematerialization, unit transfers, investor communications and statutory reporting.

Detailed responsibilities:
6.1 Investor servicing & transaction processing: RTAs process subscriptions, redemptions,
switches, handling NAV allotment, unit accounting and dispatch of account statements. They
ensure timely execution as per SEBI timelines and the scheme’s terms.
6.2 KYC & AML checks: RTAs perform KYC verification and monitor Know-Your-Customer
and anti-money-laundering compliances as per regulatory guidance.
6.3 Corporate actions & distributions: Implement dividend payouts, redemption settlements,
corporate actions and tax deduction at source processes for unit-holders.
6.4 Recordkeeping & reconciliation: Maintain secure, auditable records of unit-holder
holdings, reconcile with AMC custodian records and submit periodic reports.
6.5 Investor grievance redressal & investor charter: RTAs implement grievance mechanisms
and adhere to the investor charter standards (timelines, escalation matrix) prescribed by SEBI.
6.6 Technology, cybersecurity & business continuity: Modern RTAs are required to have
robust IT systems, disaster recovery, and cybersecurity measures — SEBI’s master circulars
provide detailed operational standards and audit requirements. These functions are codified in
SEBI Master Circulars for RTAs, which set operational, cyber security and investor servicing
norms. Securities and Exchange Board of India+1

Implications: Accurate and timely RTA functioning directly affects investor trust, NAV integrity
and the AMC’s reputation; failures can lead to regulatory action and investor harm.

7. Underwriter — role, regulation and practicalities (as per SEBI)

Role in capital markets: An underwriter is an intermediary (individual or firm) that guarantees

to subscribe for or procure subscribers to a public issuance of securities (equity or debt) when the
issue is not fully subscribed by the public. In the context of mutual funds, underwriters are more
relevant to schemes involving fresh issues (e.g., closed-ended funds at launch) or securities
markets offerings associated with AMC activity.

Detailed points:
7.1 Commitment & risk absorption: Underwriters commit to take up unsubscribed portions,
thereby ensuring the issuer (or the scheme at launch) raises the intended capital and reducing
market risk for the issuer.
7.2 Due diligence & pricing support: Underwriters perform book-building, help price the issue,
and use their distribution network to place securities. Their reputations are crucial for investor
confidence.
7.3 Regulatory registration & compliance: SEBI mandates registration/certification for
underwriters under the SEBI (Underwriters) Rules/Regulations; no person may act as an
underwriter without SEBI’s certificate. Registered underwriters must follow capital adequacy,
disclosure and conduct norms and are subject to oversight. Securities and Exchange Board of
India+1
7.4 Implications for mutual funds: For closed-ended mutual fund launches, new fund offers
(NFOs) or AMC-sponsored debt issuances, underwriters provide market assurance and
distribution muscle. Underwriter fees and the magnitude of underwriting commitments feed into
the cost structure and pricing of the offering.

8.1 Valuation challenges & illiquid securities

Mutual funds holding less liquid instruments (corporate debt, unlisted securities) must follow
robust valuation methods and markdown policies; inaccurate valuation distorts NAVs and
investor returns. SEBI mandates valuation norms and disclosure of illiquid asset exposure.

8.2 Costs & expense structure

 Expense Ratio (TER): Annual charges (management fee, trustee fee, custodian,
registrar, marketing – distribution) expressed as % of AUM; high TER erodes returns.
 Loads: Entry loads are banned in many jurisdictions; exit loads discourage short-term
trading. AMCs must clearly disclose TER and any loads.

8.3 Taxation
Tax treatment varies by scheme type and investor category. Equity funds often get preferential
long-term capital gains (subject to thresholds), while debt funds are taxed differently (indexation
benefits for long-term). Dividends from mutual funds are also subject to taxation rules (variable
over time). Investors should consult current tax rules before investing.

8.4 Risk management & compliance at AMCs

AMCs are expected to have risk frameworks — credit risk, market risk, liquidity risk,
operational risk — plus compliance with SEBI’s investment limits (single issuer exposure, group
exposure), related-party transaction rules and disclosure norms. Trustee oversight is mandatory
to ensure the AMC acts in the unit-holders’ interest.