(a) Net Value (NAV) – It is the amount which a unit holder would receive if the mutual funds were wound up. There is a Valuation Rule for valuation of assets which depends on the nature of assets. The asset values obtained on the basis of this rule is further adjusted on account of additions (in form of dividend and interest accrued and other receivables) and deductions (in form of expenses accrued and other short-term and longterm liabilities). Net Asset of the Scheme = Market Value of Investments + Receivables+ Other accrued income + Other Assets – Accrued Expenses – Other Payables – Other Liabilities NAV = Net Assets of Scheme Number of Units Cost of Mutual Funds – Broadly cost of Mutual Fund carries two components: (i) Initial Expenses – Attributing to establishing a scheme under a scheme. (ii) Ongoing Recurring Expenses – Mainly consists of Cost of employing experts, Administrative Costs and Advertisement Cost. 6. Computation of Returns Mainly investors derive three types of income from owning mutual fund units: • Cash Dividends, • Capital Gain Disbursements, and • Changes in the Fund’s NAV. The formula for computing annual return is as follows: = 1 D 1 1 0 0 CG (NAV NAV ) 100 NAV + + − × Where, D1 = Dividend CG1 = Realised Capital Gain NAV1 – NAV0 = Unrealised Capital Gain NAV0 = Base NAV 7. Criteria for Evaluating the Performance Following three ratios are used to evaluate the performance of mutual funds: (a) Sharpe – This ratio measures the return earned in excess of the riskfree rate (normally Treasury Instruments) on a portfolio to the portfolio’s total risk as measured by the Standard Deviation in its return and over the measurement period. The formula to calculate the ratio is as follows: S = Standard Deviation of Portfolio Return Portfolio − Return of Risk Free Investment (b) Treynor – This ratio is similar to Sharpe Ratio however, with a difference that it uses Beta instead of Standard Deviation. The formula to calculate this ratio is as follows: T = Return of Portfolio −Return of Risk Free Investment Beta of Portfolio
(b) Purchasing Parity (PPP): This theory focuses on the ‘inflation-exchange rate’ relationship. There are two forms of PPP theory: • Absolute Form- Also called the ‘Law of One Price’ suggests that “prices of similar products of two different countries should be equal when measured in a common currency”. If a discrepancy in prices as measured by a common currency exists, the demand should shift so that these prices should converge. • Relative Form – An alternative version that accounts for the possibility of market imperfections such as transportation costs, tariffs, and quotas. It suggests that ‘because of these market imperfections, prices of similar products of different countries will not necessarily be the same when measured in a common currency.’ In Equilibrium Form: PF PD S = α Where, S (`/$) = spot rate PD = is the price level in India, the domestic market. PF = is the level in the foreign market, the US in this case. Α = Sectoral and sectoral shares constant. (c) International Fisher Effect (IFE): According to this theory, ‘nominal risk-free interest rates contain a real rate of return and anticipated inflation’. This means if investors of all countries require the same real return, interest rate differentials between countries may be the result of differential in expected inflation. The IFE equation can be given by: rD – PD = rF – ΔPF or PD – PF = ΔS = rD –rF 7. Comparison of PPP, IRP AND IFE Theories Theory Key Variables Summary Interest Rate Parity (IRP) Forward rate premium (or discount) Interest rate differential The forward rate of one currency will contain a premium (or discount) that is determined by the differential in interest between the two countries. Purchasing Power Parity (PPP) Percentage change in spot exchange rate Inflation rate differential The spot rate of one currency with respect to another will change in reaction to the differential in inflation rates between two countries. International Fisher Effect (IFE) Percentage change in spot exchange rate Interest rate differential The spot rate of one currency with respect to another will change in accordance with the differential in interest rates between the two countries.