1.

Types of financial institutions

A financial institution is an establishment that conducts financial transactions

such as investments, loans and deposits.
Types of financial institutions are as follows:
 Investment banking houses: An organization that underwrites and distributes
new investment securities and helps businesses obtain financing. Such
organizations (a) help corporations design securities with features that are
currently attractive to investors, (b) then buy these securities from the
corporation, and (c) resell them to savers. Although the securities are sold
twice, this process is really one primary market transaction, with the
investment banker acting as a facilitator to help transfer capital from savers to
businesses.

 Commercial banks: Historically, commercial banks were the major

institutions that handled checking accounts and through which the Federal
Reserve System expanded or contracted the money supply. Today, however,
several other institutions also provide checking services and significantly
influence the money supply. Conversely, commercial banks are providing an
ever-widening range of services, including stock brokerage services and
insurance.

 Financial services corporations A firm that offers a wide range of financial

services, including investment banking, brokerage operations, insurance, and
commercial banking.

 Savings and loan associations (S&Ls) traditionally served individual savers

and residential and commercial mortgage borrowers, taking the funds of
many small savers and then lending this money to home buyers and other
types of borrowers.

 Mutual savings banks, which are like S&Ls, operate primarily in the
northeastern states, accepting savings primarily from individuals, and lending
mainly on a long-term basis to home buyers and consumers.

 Credit unions are cooperative associations whose members are supposed to

have a common bond, such as being employees of the same firm. Members’
savings are loaned only to other members, generally for auto purchases, home
improvement loans, and home mortgages. Credit unions are often the
cheapest source of funds available to individual borrowers.
 Pension funds are retirement plans funded by corporations or government
agencies for their workers and administered primarily by the trust
departments of commercial banks or by life insurance companies. Pension
funds invest primarily in bonds, stocks, mortgages, and real estate.

 Life insurance companies take savings in the form of annual premiums;

invest these funds in stocks, bonds, real estate, and mortgages; and finally
make payments to the beneficiaries of the insured parties.

 Mutual funds are corporations that accept money from savers and then use
these funds to buy stocks, long-term bonds, or short-term debt instruments
issued by businesses or government units. These organizations pool funds
and thus reduce risks by diversification. They also achieve economies of
scale in analyzing securities, managing portfolios, and buying and selling
securities. Different funds are designed to meet the objectives of different
types of savers. Hence, there are bond funds for those who desire safety,
stock funds for savers who are willing to accept significant risks in the hope
of higher returns, and still other funds that are used as interest-bearing
checking accounts (money market funds).

 Hedge funds are like mutual funds because they accept money from savers
and use the funds to buy various securities, but there are some important
differences. While mutual funds are registered and regulated by the Securities
and Exchange Commission (SEC), hedge funds are largely unregulated.
Different hedge fund managers follow different strategies. Hedge funds
generally charge large fees, often a fixed amount plus 15 to 20 percent of the
fund’s capital gains.
2. Type of financial markets

 Physical asset versus financial asset markets. Physical asset

markets (also called “tangible” or “real” asset markets) are those
for products such as wheat, autos, real estate, computers, and
machinery. Financial asset markets, on the other hand, deal with
stocks, bonds, notes, mortgages, and other claims on real assets,
as well as with derivative securities whose values are derived from
changes in the prices of other assets.

 Spot versus futures markets. Spot markets are markets in which

assets are bought or sold for “on-the-spot” delivery (literally, within
a few days). Futures markets are markets in which participants
agree today to buy or sell an asset at some future date. For
example, a farmer may enter into a futures contract in which he
agrees today to sell 5,000 bushels of soybeans six months from
now at a price of $5 a bushel. On the other side, an international
food producer looking to buy soybeans in the future may enter into
a futures contract in which it agrees to buy soybeans six months
from now.

 Money versus capital markets. Money markets are the markets

for short-term, highly liquid debt securities. Capital markets are
the markets for intermediate- or long-term debt and corporate
stocks. The New York Stock Exchange is a prime example of a
capital market. There is no hard and fast rule on this, but when
describing debt markets, “short term” generally means less than 1
year, “intermediate term” means 1 to 10 years, and “long term”
means more than 10 years.

 Primary versus secondary markets. Primary markets are the

markets in which corporations raise new capital. If GE were to sell
a new issue of common stock to raise capital, this would be a
primary market transaction. The corporation selling the newly
created stock receives the proceeds from the sale in a primary
market transaction. Secondary markets are markets in which
existing, already outstanding, securities are traded among
investors. Thus, if Jane Doe decided to buy 1,000 shares of GE
stock, the purchase would occur in the secondary market. The
New York Stock Exchange is a secondary market because it deals
in outstanding, as opposed to newly issued, stocks and bonds.
Secondary markets also exist for mortgages, various other types of
 loans, and other financial assets. The corporation whose securities
are being traded is not involved in a secondary market transaction
and, thus, does not receive any funds from such a sale.

 Private versus public markets. Private markets, where

transactions are negotiated directly between two parties, are
differentiated from public markets, where standardized contracts
are traded on organized exchanges. Bank loans and private debt
placements with insurance companies are examples of private
market transactions. Because these transactions are private, they
may be structured in any manner that appeals to the two parties.
By contrast, securities that are issued in public markets (for
example, common stock and corporate bonds) are ultimately held
by many individuals. Public securities must have standardized
contractual features, both to appeal to a broad range of investors
and because public investors do not generally have the time and
expertise to study unique, non-standardized contracts. Their wide
ownership also ensures that public securities are relatively liquid.
Private market securities are, therefore, more tailor-made but less
liquid, whereas publicly traded securities are more liquid but
subject to greater standardization.
5. Reasons for choosing mutual fund as a mode of investment

 POWER OF COMPOUNDING: Mutual funds harness the power of

compounding. Compounding is the interest that you earn on interest.
Hence, the value of your investment keeps growing at an ever-increasing
rate. Over time, compounding can lead to a significant increase in the
value of your investment.
 DIVERSIFICATION: Diversification is a key benefit of investing in a
mutual fund. It is the practice of investing in different types of securities
or asset classes. Not every asset moves in tandem; while some rise, others
fall. So, when you own both the stocks in your portfolio, any losses from
one are cancelled out by the gains in the other. Thus, diversification
reduces your overall risk.
 CAPITAL GAINS DISTRIBUTIONS: Mutual funds distribute the
profits made from selling some of their underlying assets at higher values.
This is called capital gains distribution. You can use this to buy more
mutual fund units (reinvestment).
 AUTOMATIC REINVESTMENT: A mutual fund gives returns in two
ways—dividends and an increase in value. An increase in value can be
utilised only when you sell the mutual fund units. Dividends, on the other
hand, are accessible as soon as they are distributed. You can use the
dividend amount to buy more units of the mutual fund scheme
automatically. Mutual fund dividends are tax-free for investors. However,
mutual funds are taxed for distributing dividends. This is mainly
applicable to debt mutual funds, not equity funds.
 FUND SWITCH/EXCHANGE PRIVILEGE: Many fund houses group
a set of mutual funds together based on their investment objectives or
other factors like management. You have the option to transfer your
investment within a family of funds from one scheme to another. This is
called a fund switch or exchange privilege.
 TRANSPARENCY: It is important that your money is in safe hands.
SEBI regulations have made the mutual funds industry quite transparent.
This always allows you to track your mutual fund investments. AMCs are
mandated to deliver regular updates to investors on how the funds are
faring.
 VARIETY: They say not to put all your eggs in one basket. This is true
for investing as well. Mutual fund schemes invest in a whole range of
industries and sectors, different asset types, and more. The schemes may
focus on blue-chip stocks, technology stocks, bonds, or a mix of stocks
and bonds, for example. Expect to be spoilt for choice.
  LIQUIDITY: Open-ended mutual funds allow investors to redeem their
units at any time at the prevailing NAV. So mutual funds are highly
liquid, which is beneficial for investors.

6. Market Capitalization

Market capitalization refers to the total dollar market value of a

company's outstanding shares. Commonly referred to as "market cap," it
is calculated by multiplying a company's shares outstanding by the
current market price of one share. The investment community uses this
figure to determine a company's size, as opposed to using sales or total
asset figures.
Using market capitalization to show the size of a company is important
because company size is a basic determinant of various characteristics in
which investors are interested, including risk. It is also easy to calculate.
A company with 20 million shares selling at $100 a share would have a
market cap of $2 billion

7. Net Asset Value

 Net asset value (NAV) is value per share of a mutual fund or
an exchange-traded fund (ETF) on a specific date or time. With both
security types, the per-share dollar amount of the fund is based on the
total value of all the securities in its portfolio, any liabilities the fund has
and the number of fund shares outstanding.
 In the context of mutual funds, NAV per share is computed once per day
based on the closing market prices of the securities in the fund's portfolio.
All of the buy and sell orders for mutual funds are processed at the NAV
of the trade date. However, investors must wait until the following day to
get the trade price. Mutual funds pay out virtually all their income
and capital gains. As a result, changes in NAV are not the best gauge
of mutual fund performance, which is best measured by annual total
return.
 The formula for a mutual fund's NAV calculation is straightforward:

NAV = (assets - liabilities) / number of outstanding shares.

8. Close ended v/s open ended market

Basis Close Ended Open Ended
Meaning As the name suggests, An open-ended fund
a closed-ended fund is the type of mutual
has a fixed tenure fund in which an
 which is for a short investor can enter and
duration. exit whenever he
wants. It is a plan
which continuous
infinite.
Trading In the closed ended In open ended fund,
fund, an investor can an investor can buy
invest or subscribe for and sell it from the
the period of the initial public offer and
initial offer, once the from stock exchange
initial public offer is also.
over no possibility to
invest in it.
Listing on the Stock A Closed ended fund Open ended fund is
Exchange is listed on the stock not listed on the stock
exchange. exchange.
Transaction time The closed ended Open ended fund is
fund is executed on executed on daily
real time basis. basis.
Value In the closed ended A value of an open-
fund, a value is ended fund is
defined by the determined by the net
demand and supply asset value.
force

9. Types of mutual funds based on investment objective

Every investor has a different reason for investing in financial
instruments. Some do so for making profits and increasing
wealth, while some others do so for a regular secondary source
of income. Some others invest in mutual funds for a bit of both.
Keeping these requirements in mind, there are three key kinds of
mutual funds based on the investment objective.

GROWTH FUNDS: These are schemes that promise capital

returns in the long-term. They usually invest in equities. As a
result, growth funds are usually high-risk schemes. This is
because the values of assets are subject to lot of fluctuations.
Also, unlike fixed-income schemes, growth funds usually pay
 lower dividends. They may also prefer to reinvest the dividend
money into increasing the assets under management.

BALANCED FUNDS: As the name suggests, these schemes try

to strike a balance between risk and return. They do so by
investing in both equities and debt instruments. As a result, they
are a kind of hybrid fund. Their risk is lower than equity or
growth funds, but higher than debt or fixed-income funds.

FIXED-INCOME FUNDS: These are schemes that promise

regular income for a period. For this reason, fixed-income funds
are usually a kind of debt fund. This makes fixed-income funds
low-risk schemes, which are unlikely to give you a large amount
of profit in the long-run. They pay higher dividends than growth
funds. As with debt funds, they may be further classified based
on the specific assets invested in or based on maturity.

10. What are special mutual funds?

These are funds which invest in a specific kind of assets. They may be a
kind of equity or debt fund.

 INDEX SCHEMES: Indices serve as a benchmark to measure the

performance of the market. Indices are also formed to monitor
performance of companies in a specific sector. Every index is formed of
stock participants. The value of the index has a direct relation to the value
of the stocks. However, you cannot invest in an index directly. It is
merely an arbitrary number. So, to earn as much returns as the index,
investors prefer to invest in an Index fund. The fund invests in the index
stock participants in the same proportion as the index. For example, if a
stock had a weightage of 10% in an index, the scheme will also invest
10% of its funds in the stock. Thus, it recreates the index to help the
investors earn money. Such schemes are generally passive funds as the
managers need not research much for asset allocation. As a result, the
fees are lower. They are also a kind of equity fund.

 REAL ESTATE FUNDS: These are not a sector-specific fund which

invests in realty company shares. Instead, these funds invest directly in
real estate. This may be by buying property or funding real estate
 developers. That said, they can also buy shares of housing finance
companies or their securitized assets. Risk depends on where the fund is
investing the money.

 GILT FUNDS: These schemes primarily invest in government securities.

Government debt is usually credit-risk free. Hence, the investor usually
does not have to worry about credit risk.

 INTERVAL SCHEMES: These schemes combine the features of open-

ended and closed-ended schemes. They may be traded on the stock
exchange or may be open for sale or redemption during pre-determined
intervals at NAV based prices.
 SECTOR FUNDS: These are a kind of equity scheme restrict their
investing to one or more pre-defined sectors, e.g. technology sector. Since
they depend upon the performance of select sectors only, these schemes
are inherently more risky than general schemes. They are best suited for
informed investors, who wish to bet on a single sector.

 TAX-SAVING SCHEMES: Investors are now encouraged to invest in the

equity markets through the Equity Linked Savings Scheme (ELSS) by
offering them a tax rebate. When you invest in such schemes, your total
taxable income falls. However, there is a limit of Rs 1 lakh for tax
purposes. The crutch is that the units purchased cannot be redeemed, sold
or transferred for a period of three years. However, in comparison with
other tax-saving financial instruments like Public Provident Funds (PPF)
and Employee Provident Funds (EPF), ELSS funds have the lowest lock-
in period. An example of ELSS scheme is the Kotak ELSS scheme.

 MONEY MARKET SCHEMES: These schemes – a kind of debt fund –

invest in short-term instruments such as commercial paper (CP),
certificates of deposit (CD), treasury bills (T-Bill) and overnight money
(Call). The schemes are the least volatile of all the types of schemes
because of the short-term maturities of the money-market instruments.
These schemes have become popular with institutional investors and
high-net worth individuals having short-term surplus funds.