NISM Series XXI-A: Portfolio Management (PMS) - Full-Length Test

Speculation involves taking risks in financial markets based on uncertain outcomes and often involves making decisions without significant analysis or evidence (option a). It is motivated by the potential for profit (option c), as speculators aim to capitalize on market fluctuations or expected future events. However, speculating does not guarantee higher returns; it can also result in losses due to the speculative nature of the investments involved. Therefore, option d (Speculation always leads to higher returns) is false.

The future value of an investment is influenced by both the time period (a) over which the investment grows and the rate of return (b) earned on the investment. These two factors, time period and rate of return, interact multiplicatively to determine the future value of an investment. Therefore, option c (Both a & b) is correct because both time period and rate of return play crucial roles in determining the future value of an investment.

Equity shares represent ownership in a company. Holders of equity shares are entitled to participate in the company’s profits through dividends and have voting rights in the company’s affairs, such as electing board members and voting on significant corporate decisions. Bonds (option a) and commercial papers (option b) are debt instruments and do not grant ownership or voting rights in a company, making option c (Equity Shares) the correct answer.

Liquidity Risk encompasses both aspects mentioned in options a and b:

a. The ease with which one can convert an asset into cash: This refers to the ability to sell an asset quickly and at a fair price without significantly affecting its market price.

b. The possibility of realizing almost the entire economic worth of an asset: This indicates the extent to which an asset can be sold for its true economic value, without incurring significant discounts due to market conditions or timing of the sale.

Therefore, Liquidity Risk includes both the liquidity aspect (option a) and the marketability aspect (option b) of an asset. Hence, the correct answer is c. A and B.

A preferential issue refers to the issuance of shares by a listed company to a select group of investors (such as institutional investors, promoters, or private equity funds) without offering them to the public or existing shareholders through a rights issue. The company issues shares at a predetermined price, which is often lower than the current market price, to the selected group of persons.

For the public issue of a debt security, it is essential that the debt instruments are credit rated. Credit rating involves assessing the creditworthiness of the issuer and the specific debt instruments being issued. This rating helps investors evaluate the risk associated with the investment and provides transparency regarding the issuer’s ability to repay the debt. It is a critical step in ensuring investor confidence and market participation in the issuance of debt securities.

a. Provide liquidity for securities issued: Secondary markets allow investors to buy and sell already issued securities, providing liquidity and enabling price discovery.

b. Provide a platform for making public issues: While primary markets handle initial public offerings (IPOs), secondary markets also facilitate trading of newly issued securities after they are listed.

c. Provide information about public companies: Secondary market trading contributes to price transparency and informs investors about the valuation and performance of public companies. Therefore, the correct answer is

d. All the above, as secondary markets fulfill these essential roles in the financial system.

Cyclical industries are those whose performance closely mirrors the overall economic cycle. They tend to experience significant fluctuations in demand and profitability based on economic conditions such as GDP growth, consumer spending, and business investment. Therefore, option a (Cyclical) is the correct answer as it describes industries that rise and fall in tandem with broader economic trends.

In a Nifty 50 futures contract, the underlying asset is the value of the Nifty 50 index itself. This index represents the weighted average market capitalization of the top 50 companies listed on the National Stock Exchange of India (NSE), making it the correct answer.

In futures contracts, the settlement price is often determined as the weighted average price of transactions during the final 30 minutes of trading. This approach helps to reduce volatility and ensures a representative closing price that reflects market consensus at the end of the trading session.

Counterparty risk in futures contracts is primarily mitigated through the functions provided by the clearing corporation. Clearing corporations act as intermediaries, ensuring that both parties fulfill their obligations by requiring margin deposits, managing risk through daily settlement, and providing guarantees against default. This mechanism helps to safeguard against the potential failure of one party to honor its obligations under the contract.

Callability refers to the issuer’s right to redeem or retire bonds before their maturity date by paying a specified call price or premium to bondholders. This feature gives issuers flexibility in managing their debt obligations, particularly in changing interest rate environments or when refinancing becomes advantageous.

The putability feature, also known as a put option, grants bondholders the right to sell the bond back to the issuer under specified conditions. This provides investors with an exit strategy if certain predefined events occur, such as a decline in the issuer’s credit quality or adverse market conditions.

Arbitrage opportunities can exist between various types of prices, including spot and futures prices, two different futures prices, and futures and options prices. Arbitrageurs seek to exploit price differentials between these markets to earn risk-free profits by simultaneously buying and selling related assets or contracts to capture inefficiencies in pricing.

A mutual fund is a type of investment vehicle that pools together money from many investors to purchase securities such as stocks, bonds, and other assets. The fund is managed by professional fund managers who invest the pooled money in accordance with the fund’s stated investment objective. Investors in mutual funds share in the gains and losses of the fund’s holdings in proportion to their investment.

Investing through mutual funds offers several advantages, including:

• Professional investment management: Mutual funds are managed by experienced professionals who make investment decisions on behalf of investors.
• Risk reduction through diversification: Mutual funds invest in a diversified portfolio of securities, spreading risk across different asset classes and companies.
• Convenience of making transactions and record-keeping: Investors can buy, sell, and track their investments in mutual funds easily through various platforms and services provided by fund companies and brokers.

These benefits make mutual funds a popular choice for individual investors looking to achieve diversification and professional management of their investments.

The types of securities purchased by a mutual fund or any investment fund are determined based on the investment objectives of the fund. These objectives outline the goals and strategies that the fund aims to achieve with its investments, guiding the fund manager’s decisions on asset allocation and security selection. The investment objectives typically define whether the fund will invest in stocks, bonds, money market instruments, or other types of securities, based on factors such as risk tolerance, return expectations, and time horizon.

Open-ended schemes are mutual funds that offer continuous sale and purchase of units at Net Asset Value (NAV) or NAV-related prices. Investors can enter and exit these schemes at any time during their operation, as they do not have a fixed maturity or specific time frame. This flexibility distinguishes open-ended schemes from close-ended schemes, which have a fixed maturity period, and interval schemes, which combine features of both open and close-ended schemes with specific intervals for transactions.

The SEBI (Mutual Funds) Regulations were first introduced in 1996 by the Securities and Exchange Board of India (SEBI) to regulate and oversee the operations of mutual funds in India. These regulations have since been amended and updated periodically to adapt to changes in the financial markets and to enhance investor protection and transparency in the mutual fund industry.

As per SEBI (Portfolio Managers) Regulations, 2020, the minimum net worth requirement for entities to be registered as Portfolio Managers (PMS providers) is Rs. 5 crore. This financial requirement is set by SEBI to ensure that PMS providers have adequate capital to manage client portfolios and meet regulatory standards effectively.

An investment approach is a broad outline of the type of securities and permissible instruments that a portfolio manager will use to invest on behalf of clients. This approach takes into consideration various factors specific to both clients and the securities being considered for investment.

Under SEBI’s Portfolio Managers Regulations 2020, to obtain a certificate of registration as a portfolio manager, the applicant must fulfill several criteria:

• The applicant must be a body corporate.
• The applicant must have the necessary infrastructure, including adequate office space, equipment, and manpower, to effectively carry out portfolio management activities.
• The applicant must appoint a compliance officer to ensure adherence to regulatory requirements and guidelines.

A non-discretionary portfolio manager manages funds based on specific instructions and directions provided by the client. They do not have the authority to make independent investment decisions or trades on behalf of the client without client approval. This ensures that investment decisions align closely with the client’s preferences and objectives, as specified in the client’s instructions.

Risk profiling is a crucial first step in PMS. It helps the portfolio manager understand the client’s: – Risk tolerance: How much risk the client is willing to take. – Financial status: Their income, assets, and liabilities. – Investment objectives: Their goals, time horizon, and specific needs

Momentum factor funds track stocks with strong upward price trends, aiming to capitalize on continued momentum. While offering high return potential, they carry risks like volatility and market corrections.

The credit spread represents three components: (1) the interest rate difference between government and corporate securities, (2) the risk premium companies pay to raise debt, and (3) the additional yield investors demand for bearing default risk. Together, they signify the perceived creditworthiness of the corporate issuer.

Equity markets are volatile in the short term, making it difficult to consistently predict market movements. By staying invested for a longer period, investors benefit from the overall growth of the market, where short-term fluctuations tend to even out over time. Therefore, “time in the market” is preferred over “timing the market.”

Currently there are 5 KYC Registration Agencies in India viz. –

1. Computer Age Management Services Limited (CAMS)

2. NSDL Database Management Limited

3. Karvy Data Management Services (KFintech)

4. Dotex International Limited 5. CDSL Ventures Limited

Investing in debt funds carries various types of risk. These risks include Credit risk (Default Risk), Interest rate risk, Inflation risk, reinvestment risk etc. Credit Risk (Default Risk): The chances that a borrower might not repay the interest or principle on the committed date is considered as credit risk or default risk. Interest rate risk : Market price of the bond and interest rates carry opposite relationship. Whenever interest rates in the market go up, the market prices of bond come down

The Free Cash Flow to Equity (FCFE) model is particularly useful for leveraged firms because it explicitly considers the impact of debt financing. It calculates the cash available to equity shareholders after accounting for:

1. Operating cash flows
2. Capital expenditures (CapEx)
3. Debt repayments and new borrowings

This makes FCFE a strong valuation tool for firms with high leverage, as it adjusts for financial obligations before determining shareholder value.

SEBI regulations require portfolio managers to keep client funds in a scheduled commercial bank to ensure: Liquidity – Funds must be readily available for investments and withdrawals as per the client’s needs. Security – Scheduled commercial banks are regulated by the Reserve Bank of India (RBI), ensuring the safety of client funds. Transparency – Keeping funds in regulated banks helps maintain proper records and prevents misuse.

Under the Prevention of Money Laundering Act (PMLA), enhanced due diligence (EDD) is required for high-risk clients to prevent illicit financial activities. This involves: Checking Ownership – Ensuring the client is the legitimate owner of the assets. Checking Fund Source – Identifying where the funds originate to detect suspicious activities. Assessing Financial Position – Ensuring the client’s financial activities align with their declared income and business.

Differentiating between high and low-priority goals helps in allocating resources efficiently, choosing the right investment strategies, and balancing risk and return.

Prioritization and Resource Allocation:

– High-priority goals (e.g., retirement, children’s education) typically require larger investments and a more conservative approach.

– Low-priority goals (e.g., a vacation, a new gadget) might be funded with smaller, more flexible investments.

– Differentiating allows for tailored investment strategies and asset allocations to match the importance and timeline of each goal.

A Portfolio Manager is required to report all beneficial interests that arise from the investments managed on behalf of the client. These include:

1. Interest and Dividend – Earnings received from bonds, fixed-income securities, and dividendpaying stocks

2. Bonus Shares and Right Shares – Additional shares allotted to investors due to corporate actions.

Since both categories constitute financial benefits to the client, the portfolio manager must report both.

The key difference is Customization.

PMS : Offers highly customized investment portfolios tailored to individual investor’s specific needs, risk tolerance, and financial goals.

Mutual Funds : Provide standardized investment portfolios that follow a predetermined investment objective

Portfolio managers are required to inform their clients about the Investor Charter and make it publicly accessible by displaying it on their website. This ensures transparency and helps investors understand their rights, obligations, and grievance redressal mechanisms.

Asset allocation involves spreading investments across different asset classes (e.g., stocks, bonds, gold, real estate) with varying risk and return characteristics. This diversification helps to reduce the overall risk of the portfolio. If one asset class performs poorly, others may perform well, offsetting the losses.

Every portfolio manager shall appoint a Compliance Officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc., issued by SEBI or the Central Government and for redressal of investors’ grievances. The compliance officer shall immediately and independently report to SEBI any non- compliance observed.