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Jitendra
Virahya
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STUDY ON
PORTFOLIO MANAGEMENT
IN CONTEXT TO
Jitendra
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Virahyas
PREFACE
There is a vast difference between theory and practice. The practical training
program is designed with the purpose of bridging gap between theory and
practice. As such I am fortunate to have an opportunity to undergo my project
and thus my practical training with Reliance Life Insurance Company
Limited.
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Summer training was an exposure to corporate functional environment. It was
opportunity & great pleasure for me to be in Corporate Environment and having
interaction with concerned people.
This project is based on a brief study of six weeks of training period. Efforts
have been made to present all authentic information as far as possible.
ACKNOWLEDGEMENT
With a sense of great pleasure & satisfaction I present this report entitled as the
“Study on Portfolio Management in context to Reliance Life Insurance
“culmination of my efforts of last six weeks. Completion of this project, is no
doubt, is a product of invaluable support & contribution of a number of people.
I wish to express my gratitude to those who generously helped me in
completing this research work with their knowledge & expertise. A project of
this nature calls for intellectual nourishment, professional help &
encouragement from various quarters.
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I present my gratitude to project guide Mr., Sr. Sales Manager for giving me the
opportunity to work for Reliance Life Insurance Company Ltd., for being
constant guiding force & a source of Illumination throughout this entire period .
would also extend my gratitude to Mr. va (Executive Territory Manager) for his
useful suggestions.
My special thanks to all employees of Reliance Life Insurance Company Ltd,
Jhalawar, who extended their precious cooperation & for the patience they
showed while entertaining my queries.
I am immensely thankful to all agents who took out time from their busy
schedule and enthusiastically responded to my queries and provided me with al
the valuable information.
TABLE OF CONTENTS
1. Reliance Life - The Great Founder
• ADA Group Structure
• About Reliance Life
• Vision & Mission
• Vision
• Mission
• Goals
• Achievements
• Leadership Team
• Corporate Offices
2. Insurance - A Brief Introduction
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• General
• Malhotra Committee Report
• Structure
• Competition
• Regulatory Body
•Investments
• Customer Service
3. Purpose & need of Insurance in India
4. IRDA Regulations pertaining to Agents / Agency in brief
• Definitions
• IRDA guidelines for Agents
• Insurance Act, 1938
5. Investment Portfolio Management
• Industry Scope
• Key Problems of running such businesses
• Size of Global Fund Management Industry
• Philosophy, Process and People
6. Investment Managers and portfolio Structure
• Investment styles
• Performance Measurement
• Risk Adjusted performance measurement
• Security
7. Classification of Securities
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8. Classification of Funds
• Debt
• Equity
• Hybrid
9. The Securities Market• Public offer and private placement
• Physical nature of securities
• Divided and Un-divided securities
• Recruitment & selection
10. Types of Financial Market
• Raising capital
• Derivative Products
• Analysis of Financial
• Market Financial Markets in Popular Culture
11. Measuring financial Instruments
• Loss or Gain
• Risk and return
• Diversification
• Capital allocation line
• The risk free assets
• Systematic risk and specific risk
12. Diversification
• Return Expected while diversifying
13. Reliance life Portfolio Management
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• The Analyst
• Different Fund options
14. Conclusion
15. Recommendations
16. Bibliography
17. Annexure
• LIC act 1938
• Constitution of LIC
ABSTRACT
Investment Portfolio Management is the professional management o
various securities (shares, bonds etc.) and assets (e.g., real estate), to meet
specified investment goals for the benefit of the investors.
Investors may be institutions (insurance companies, pension funds, corporations
etc.) or private investors (both directly via investment contracts and more
commonly via collective investment schemes e.g. mutual funds or Exchange
Traded Funds) .
The term asset management is often used to refer to the investment
management of collective investments, (not necessarily) whilst the more
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generic fund management may refer to all forms of institutional investment
as well as investment management for private investors. Investment managers
who specialize in advisory or discretionary management on behalf of (normally
wealthy) private investors may often refer to their services as wealth
management or portfolio management often within the context of so-called
"private banking".
The provision of 'investment management services' includes elements o
financial analysis, asset selection, stock selection, plan implementation and
ongoing monitoring of investments. Investment management is a large and
important global industry in its own right responsible for caretaking of trillions of
dollars, euro, pounds and yen. Coming under the remit of financial services
many of the world's largest companies are at least in part investment managers
and employ millions of staff and create billions in revenue.
Fund manager (or investment adviser in the India.) refers to both a firm
that provides investment management services and an individual who directs
fund management decisions.
Investment Philosophy of Reliance Life
Reliance Life Insurance seeks consistent and superior long-term returns
with a well defined and discipline investment approach symbolizing
integrity and transparency to all stakeholders
Reliance Life offers the different fund options to the
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Customers
• ULIP Equity
• Pure Equity
• Infrastructure
• Mid-Cap
• Energy
• Super Growth
• High Growth
• Growth Plus
• Growth
• Balanced
• Corporate Bond
• Pure Debt
• Gilt
• Guaranteed Bond-I
• Money Market
• Capital Secure
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The Great Founder
"Pursue your goals even in the face of difficulties, and
convert adversities into opportunities."
- Dhirubhai Hirachand Ambani
Few men in history have made as dramatic a contribution to their country’s
economic fortunes as did the founder of Reliance, Shri. Dhirubhai H Ambani
Fewer still have left behind a legacy that is more enduring and timeless.
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As with all great pioneers, there is more than one unique way of describing the
true genius of Dhirubhai: The corporate visionary, the unmatched strategist, the
proud patriot, the leader of men, the architect of India’s capital markets, the
champion of shareholder interest. But the role Dhirubhai cherished most was
perhaps that of India’s greatest wealth creator. In one lifetime, he built, starting
from the proverbial scratch, India’s largest private sector enterprise.
When Dhirubhai embarked on his first business venture, he had a seed capita
of barely US$ 300 (around Rs 14,000). Over the next three and a half
decades, he converted this fledgling enterprise into a Rs. 3,25,000 crore
colossus—an achievement which earned Reliance a place on the global
Fortune 500 list, the first ever Indian private company to do so.
Under Dhirubhai’s extraordinary vision and leadership, Reliance scripted one of
the greatest growth stories in corporate history anywhere in the world, and
went on to become India’s largest private sector enterprise.
Through out this amazing journey, Dhirubhai always kept the interests of the
ordinary shareholder uppermost in mind, in the process making millionaires out
of many of the initial investors in the Reliance stock, and creating one of the
world’s largest shareholder families.
ADA Group Structure
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About Reliance Life Insurance
Reliance Life Insurance offers you products that fulfill your savings and
protection needs. Our aim is to emerge as a transnational Life Insurer of globa
scale and standard.
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Reliance Life Insurance is an associate company of Reliance Capital Ltd., a part
of Reliance - Anil Dhirubhai Ambani Group. Reliance Capital is one of India’s
leading private sector financial services companies, and ranks among the top 3
private sector financial services and banking companies, in terms of net worth
Reliance Capital has interests in asset management and mutual funds, stock
broking, life and general insurance, proprietary investments, private equity andother activities in financial services.
Reliance - Anil Dhirubhai Ambani Group also has presence in
Communications, Energy, Natural Resources, Media, Entertainment, Healthcare
and Infrastructure.
Vision & Mission
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Vision
Empowering everyone live their dreams.
MissionCreate unmatched value for everyone through dependable
effective, transparent and profitable life insurance and
pension plans.
Our Goal
Reliance Life Insurance would strive hard to achieve the 3goals mentioned below:
1. Emerge as transnational Life Insurer of global scale andstandard
2. Create best value for Customers, Shareholders and allStake holders
3. Achieve impeccable reputation and credentials through best business practices
Achievements
• RLIC has been one of the fast gainers in market share in new business
premium amongst the private players with an incremental market share
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of 4.1% in the Financial Year 2007-08 – from 3.9% in April 07 to 8% in Feb
08. ( Source: IRDA)
• Also continues to be amongst the fast growing Private Life
Insurance Companies with a YOY growth of 195% in new business
premium as of Mar’08.
• A Company that has crossed 1.7 Million policies in just 2 years of
operation, post take over of AMP Sanmar business.
• Initiated Express Life – an Unique ’Over the Counter’ sales process for
Unit Linked Insurance Policies in the Industry.
• Accomplished a large distribution ramp-up in the Industry in a short span
of time by opening 600 branches in 10 months taking the overalbranch network above 740.
• RLIC continues to be one of the two Life Insurance companies in India to
be certified ISO 9001:2000 for all the processes.
• Awarded the Jamnalal Bajaj Uchit Vyavahar Puraskar 2007
Ceritificate of Merit in the Financial Services category by Council for
Fair Business Practices (CFBP).
Leadership Team
BOARD OF DIRECTORS
Gautam Doshi, Director
Gautam is the Group Managing Director of Reliance Anil Dhirubhai Amban
Group and Director of Reliance Life Insurance Company Limited.
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Satya Pal Talwar, Director
Satya Pal is the Director of Reliance Life Insurance Company Limited. He holds
an experience of more than 35 years in operations and policy formulation.
Saumen Ghosh, Group President
Saumen is currently the Group President of Reliance Capital Limited.
Malay Ghosh – President & Deputy CEO
Malay leads all Sales & Distribution activities at Reliance Life Insurance
Company Limited. His key focus is on rapid expansion of all channels and
accelerating the company’s growth trajectory.
Maneesha Thakur, Chief Human Resources Officer
Maneesha in her role as the Chief Human Resource Officer at Reliance Life
Insurance Company Limited, has developed a performance driven and
employee centric culture. She has been at the forefront of the organization
growth by facilitating talent acquisition and management.
Pournima Gupte, Appointed Actuary
Pournima is the Appointed Actuary at Reliance Life Insurance Company Limited
where she has the overall responsibility for statutory reporting, risk appetite
pricing, valuation, reinsurance, etc.
Leadership Team
BOARD OF DIRECTORS
C Mohan, Chief Technology Officer
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Mohan is the Chief Technology Officer (CTO) of Reliance Life Insurance
Company Limited and he is responsible for Information Technology Strategy
Formulation and Deployment.
R Rangarajan, Chief Investment Officer
Rangarajan is the Chief Investment Officer at Reliance Life Insurance CompanyLimited. He along with his team strives to give the best possible returns on
investments to shareholders and policyholders, keeping in mind their appetite
for risk. Rangarajan draws on his in-depth knowledge of investment and
experience of 25 years to ensure that the goals of the organization are met—
without any compromise on the benefits of the investors.
S V Sunder Krishnan, Chief Risk Officer
Sunder is the Chief Risk officer for Reliance Life Insurance and is responsible for
overseeing Risk Management, Internal Audit and Compliance functions at
Reliance Life Insurance.
Saroj K Panigrahi, Head – Legal, Compliance & Company Secretary
'Saroj K Panigrahi heads the Legal, Compliance and Company Secretaria
function of Reliance Life Insurance'. He is armed with twelve years of valuable
experience in the Corporate Legal, Commercial, Regulatory Compliance and
Corporate Governance domains.
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Corporate Offices
Call us at our 24 x 7 Call Center number-3033 8181 OR our Toll Free Number
1800 300 08181
Email us at [email protected]
Write to us at –
Registered Office:
H Block, 1st Floor,
Dhirubhai Ambani KnowledgeCity,
Navi Mumbai, Maharashtra -
400710.
Corporate Office:
Level 1, Midas Wing - A,
Sahar Plaza, Andheri Kurla Road,Andheri (East) Mumbai - 400 059.
Phone No: +91-22-3088 3444
Fax No: +91-22-3088 6587
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A BRIEF INTRODUCTION
In General
The business of insurance started with marine business. Traders, who used to
gather in the Lloyd’s coffee house in London, agreed to share the losses of thei
goods while being carried by ships. The losses use to occur because of pirates
who robbed on the high seas or because of the bad weather spoiling the goods
or sinking the ships. The first insurance policy was issued in 1583 in England. In
India, insurance began in 1870 with life insurance being transacted by an
English company, “the European and the Albert”. The first insurance company
was the Bombay Mutual Assurance Ltd.
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In the wake of Swadeshi Movement in India in early 1900’s, quite a good
number of Indian companies were formed in the various parts of the country to
transact insurance business. To name a few: ‘Hindustan Cooperative’ and
‘National Insurance’ in Kolkatta; ‘United India’ in Chennai; ‘Bombay Life’, ‘New
India’ and ‘Jupiter’ in Mumbai and ‘Lakshmi Insurance’ in New Delhi.
In 1956, life insurance business was nationalized and LIC of India came into
being on 1.09.1956. The Government took over the business of 245 companies
(including 75 provident fund societies) who were transacting life insurance
business at that time. There after, LIC got the exclusive privilege to transact life
insurance business in India.
Malhotra Committee Report
In 1993, Malhotra Committee headed by former Finance Secretary and RB
Governor R. N. Malhotra, was formed to evaluate the Indian insurance industry
and recommend its future direction.
The Malhotra committee was set up with the objective of complementing the
reforms initiated in the financial sector.
The reforms were aimed at “creating a more efficient and competitive financia
system suitable for the requirements of the economy keeping in mind the
structural changes currently underway and recognizing that insurance is an
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important part of the overall financial system where it was necessary to address
the need for similar reforms…”
In 1994, the committee submitted the report and some of the key
recommendations included:
i) Structure
Government stake in the Insurance Companies to be brought down to
50%
All the insurance companies should be given greater freedom to operate
ii) Competition
Private Companies with a minimum paid up capital of Rs.1bn should be
allowed to enter the industry
No Company should deal in both Life and General Insurance through a
single entity
Foreign companies may be allowed to enter the industry in collaboration
with the
Domestic companies
iii) Investments
Mandatory Investments of LIC Life Fund in government securities to be
reduced
from 75% to 50%
iv) Customer Service
Companies should pay interest on delays in payments beyond 30 days.
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Computerization of operations and updating of technology to be carried
out in the insurance industry .
The committee emphasized that in order to improve the customer services and
increase the coverage of the insurance industry should be opened up to
competition. But at the same time, the committee felt the need to exercise
caution as any failure on the part of new players could ruin the public
confidence in the industry.
Hence, it was decided to allow competition in a limited way by stipulating the
minimum capital requirement of Rs.100 crores. The committee felt the need to
provide greater autonomy to insurance companies in order to improve their
performance and enable them to act as independent companies with economic
motives. For this purpose, it had proposed setting up an independent regulatory
body.
Relevant laws were amended in 1999 and LIC’s monopoly rights to transact the
insurance business in India came to an end. At the close of financial year ending
31 March 2004 twelve new companies were registered with the Insurance
Regulatory and Development Authority (IRDA) to transact life insurancebusiness in India.
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PURPOSE AND NEED OF INSURANCE
IN INDIA
Assets are insured because they are likely to be destroyed through accidenta
occurrences called perils. Few examples of perils are fire, floods, lightening,
breakdowns, earthquakes, etc. perils are the events. Risks are the
consequential losses or the damages.
The risk only means that there is only possibility of loss or damages. The
damage may or may not happen. Insurance is done against the contingency
that it may happen. There has to be an uncertainty about the risk. Insurance is
relevant if there are uncertainties. If there are no uncertainties about the
occurrence of any event it cannot be insured against. In the case of human
being, death is certain, but the time of death is uncertain. In the case of aperson who is terminally ill, the time of death is not uncertain, though exactly
not known. He cannot be insured.
Life insurance should ideally be bought for what it was always intended to do –
indemnify the nominees in case of an eventuality. Keeping this in mind al
individuals should have a term plan in their insurance portfolio, irrespective of
their profile. To take care of the investment and the ‘tax-saving’ elements
individuals can invest in tax saving Unit linked insurance plans (ULIPs), which
can invest up to 100% of the premium in market-linked instruments, is also an
option, which individuals can opt for.
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Life insurance can help in bringing economic development in the country by
mobilizing public savings. Funds collected form the public is utilized in
investment for economic growth. In any other investment or saving avenue, like
bank deposits, savings certificates or mutual funds or shares and stocks etc.
amount of funds available at any time will not be more than the amount saved,
appreciation or interest earned till then. In life insurance, the amount available
is the one that one wished to have at end of the savings period, which mayrange up to 30 or even more years.
Life insurance has advantages over other forms of savings:
Facility of nomination and assignment makes the claim settlement easy
on death
Life insurance involves compulsory savings
Tax benefits on premium paid as well as on the amount received by way
of claim
Loans can be insured against a life insurance policy.
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Mechanism of Insurance
The concept of insurance is that people exposed to the same risk come
together and agreed to share a loss collectively if any of their members
suffers it from that risk.
Insurance companies play the role of implementing this concept-
a) They bring together people exposed to the similar risk
b) They collect members’ contribution in advance in the shape o
premiums and create a fund out of which the losses are paid
The life insurance covers contingencies (death, retirement) and provides
relief to the family in the event of death or retirement of the breadwinner.
Variable needs of life insurance can be
a) Providing financial security to the family
b) Provision for education, marriage, etc of the children
c) Post-retirement income for self and dependents
d) Special needs like Medical expenses
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INSURANCE ACT, 1938
The Insurance Act, 1938 aimed ‘to consolidate and amend the law relating to
the business of insurance. It covers both life and non-life insurance business.
It came into effect on 1st. July 1939.
The act was amended in 1950 and again in 1999. Some of the Major changes
brought about in 1950 were:
Section 2 (5A)
‘Chief Agent’ means person who, not being a salaried employee of an insurer, in
consideration of commission
Performs any administrative and organizing function for the insurer.
Procures life insurance business for the insurer by employing or causing
to be employed, insurance agents on behalf of the insurer.
Section 2(17)
“Special Agent’ means a person who, not being a salaried employee of an
insurer, in consideration of commission:
Procures life insurance business for the insurer whether wholly or in part
by employing or causing to be employed insurance agents on behalf of
the insurer, but does not include a chief agent.
He only procures business through agents but does not perform anyadministrative function like a chief agent.
Special agents can do only life insurance business and not general insurance
business.
Individuals, companies or firms can become chief agents or special agents
Individuals, Directors or Partners, as the case may be, should be free from
disqualifications specified for agents.
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Section 42A,
The certificate shall remain valid for a period of 12 months but shall be
renewable.
Provisions stipulate the number of insurance agents that a ‘chief agent
may employ directly or through ‘special agents’. These provisions also
stipulate the minimum business requirements.
For ‘special agents’ also there are similar stipulations of minimum numbe
of agents to be appointed and the minimum business requirements.
Some important Provisions of the Insurance Act, 1938
1. Registration of Insurance companies.
2. Maintenance and scrutiny of accounts and valuation reports.
3. Investment and utilization of funds.
4. Placing limits on the expenses of insurers.
5. Licensing of agents and their remuneration.
6. Prohibition of rebates.
7. Approval of premium rates and plans.
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8. Maintaining solvency levels.
9. Constitution of Insurance Associations, Insurance Councils and Tarif
Advisory Committees.
10. The Act also vests the IRDA with powers to:
• Inspect documents.
• Appoint additional directors.
• Issue directions.
• Takeover the management of the insurer through the appointment
of an Administrator by the Central Government.
11. Protection of the policy holder’s interest by prohibition of policies from
being called into question after 2 years. [Sec. 45]
12. Provision of nomination. [Sec. 39]
13. Provision for assignment. [Sec. 38]
14. Provision for easy settlement of dispute.
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About IRDA
Composition of Authority under IRDA Act, 1999
As per the section 4 of IRDA Act' 1999, Insurance Regulatory and Development
Authority (IRDA, which was constituted by an act of parliament) specify the
composition of Authority
The Authority is a ten member team consisting of
(a) a Chairman;
(b) five whole-time members;
(c) four part-time members,
(all appointed by the Government of India)
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Duties, Powers and Functions of IRDA
Section 14 of IRDA Act, 1999 lays down the duties, powers and functions of
IRDA..
(1) Subject to the provisions of this Act and any other law for the time being
in force, the Authority shall have the duty to regulate, promote and ensure
orderly growth of the insurance business and re-insurance business.
(2) Without prejudice to the generality of the provisions contained in sub-
section (1), the powers and functions of the Authority shall include, -
(a) Issue to the applicant a certificate of registration, renew, modify,
withdraw, suspend or cancel such registration;
(b) protection of the interests of the policy holders in matters concerning
assigning of policy, nomination by policy holders, insurable interest,
settlement of insurance claim, surrender value of policy and other terms
and conditions of contracts of insurance;
(c) specifying requisite qualifications, code of conduct and practical
training for intermediary or insurance intermediaries and agents;
(d) Specifying the code of conduct for surveyors and loss assessors;
(e) Promoting efficiency in the conduct of insurance business;
(f) Promoting and regulating professional organizations connected with
the insurance and re-insurance business;
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(g) Levying fees and other charges for carrying out the purposes of this
Act;
(h) calling for information from, undertaking inspection of, conducting
enquiries and investigations including audit of the insurers
intermediaries, insurance intermediaries and other organizations
connected with the insurance business;
(I) control and regulation of the rates, advantages, terms and conditions
that may be offered by insurers in respect of general insurance business
not so controlled and regulated by the Tariff Advisory Committee undersection 64U of the Insurance Act, 1938 (4 of 1938)
(j) Specifying the form and manner in which books of account shall be
maintained and statement of accounts shall be rendered by insurers and
other insurance intermediaries;
(k) Regulating investment of funds by insurance companies;
(l) Regulating maintenance of margin of solvency;
(m) Adjudication of disputes between insurers and intermediaries or
insurance intermediaries;
(n) Supervising the functioning of the Tariff Advisory Committee;
(o) Specifying the percentage of premium income of the insurer to
finance schemes for promoting and regulating professional organizations
referred to in clause (f);
(p) Specifying the percentage of life insurance business and general
insurance business to be undertaken by the insurer in the rural or social
sector; and
(q) Exercising such other powers as may be prescribed
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List of Life Insurers
S.No
NAME OF THE COMPANY NAME OFAPPOINTEDACTUARY
TELEPHONENO./FAX No./E-
MAIL & WEBADDRESS
1. Bajaj Allianz Life InsuranceCompany Limited .
Mr. Anil KumarSingh
Tel : 020-4026666Fax : 020-4026789
2. Birla Sun Life Insurance Co. Ltd Mr. Fabien Jeudy
Tel : 022 5678 3333Fax: 022 5678 3232
3. HDFC Standard Life Insurance Co.Ltd
Mr. William John Martin
Tel : 022-67516666Fax: 022-2822 8844
4. ICICI Prudential Life Insurance Co.Ltd
Mr. Avijit Chatterjee Tel :022-56621996Fax: 022-56622031
5. ING Vysya Life Insurance Company Ltd.
Ms.Hemamalini
Ramakrishnan
Tel : 080-25328000Fax: 080-25559764
6. Life Insurance Corporation of India Mr. T Bhargava Tel 56598701Fax: 22824386
7. Max New York Life Insurance Co.Ltd
Mr.JohnCharles Poole
Tel : 0124-2561717Fax: 0124-2561764
8. Met Life India Insurance CompanyLtd.
Mr. M S V SPhanesh
Tel : 080-26438638Fax: 080-26521970 Toll Free No. 1-600-44-6969
9. Kotak Mahindra Old Mutual LifeInsurance Limited
Mr. AndrewWillisCartwright
Tel : 022-6621 5999Fax:022-6621 5757,6621 5858
10. SBI Life Insurance Co. Ltd Mr. SanjeevKumar Pujari
Tel : 022-56392000Fax: 022-56621471
11. Tata AIG Life Insurance CompanyLimited
Mr. HeerakBasu
Tel : 022-66516000Fax : 022-66550711
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12 Reliance Life Insurance CompanyLimited.
Ms. PournimaGupte
Tel : 022-30479600/30479784Fax: 022-30479650
13 Aviva Life Insurance CompanyIndia Limited
Mr. ChandanKhasnobis
Tel: 0124-2709000/01,Fax: 0124-2709007.
14 Sahara India Life Insurance Co,
Ltd.
Mr. K K Dharni Tel: 0522-2337777
Fax: 0522-2378200
15 Shriram Life Insurance Co, Ltd. Mr N S Sastry Tel: 040-23434466-72Fax: 040-23434488
16 Bharti AXA Life InsuranceCompany Ltd.
Mr. G L NSarma
Tel: 022 –40306300/6301Fax: 022 -40306347
17 Future Generali India LifeInsurance Company Limited
Mr. GorakhnathAgarwal
Tel No.:
022-40976666
18 IDBI Fortis Life Insurance CompanyLtd.,
Mr. Michael JWood
Tel No.:
022-24908109/10
Fax No.:
022-24941016
19 Canara HSBC Oriental Bank of
Commerce Life InsuranceCompany Ltd.
Mr. Paul
Beresford
Tel: 0124– 44215706Fax: 0124- 4201109
20 AEGON Religare Life InsuranceCompany Limited.
Mr. K.S.Gopalakrishnan
Tele No.-022-67292929
21 DLF Pramerica Life Insurance Co.Ltd.
Mr. PradeepKumar Thapliyal
Ph. No.-91-124-271700
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22 Star Union Dai-ichi Life InsuranceCo. Ltd.,
Mr. ISAMBASIVARAO
Phone: 022-32909099
Investment Portfolio management
Investment Portfolio Management is the professional management o
various securities (shares, bonds etc.) and assets (e.g., real estate), to meet
specified investment goals for the benefit of the investors. Investors may be
institutions (insurance companies, pension funds, corporations etc.) or private
investors (both directly via investment contracts and more commonly via
collective investment schemes e.g. mutual funds or Exchange Traded Funds) .
The term asset management is often used to refer to the investment
management of collective investments, (not necessarily) whilst the more
generic fund management may refer to all forms of institutional investment
as well as investment management for private investors. Investment managerswho specialize in advisory or discretionary management on behalf of (normally
wealthy) private investors may often refer to their services as wealth
management or portfolio management often within the context of so-called
"private banking".
The provision of 'investment management services' includes elements o
financial analysis, asset selection, stock selection, plan implementation and
ongoing monitoring of investments. Investment management is a large and
important global industry in its own right responsible for caretaking of trillions of
dollars, euro, pounds and yen. Coming under the remit of financial services
many of the world's largest companies are at least in part investment managers
and employ millions of staff and create billions in revenue.
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Fund manager (or investment adviser in the India.) refers to both a firm
that provides investment management services and an individual who directs
fund management decisions.
Industry scope
The business of investment portfolio management has several facets, including
the employment of professional fund managers, research (of individual assets
and asset classes), dealing, settlement, marketing, internal auditing, and the
preparation of reports for clients. The largest financial fund managers are firmsthat exhibit all the complexity their size demands. Apart from the people who
bring in the money (marketers) and the people who direct investment (the fund
managers), there are compliance staff (to ensure accord with legislative and
regulatory constraints), internal auditors of various kinds (to examine interna
systems and controls), financial controllers (to account for the institutions' own
money and costs), computer experts, and "back office" employees (to track and
record transactions and fund valuations for up to thousands of clients peinstitution).
Key problems of running such businesses
Key problems include:
• Revenue is directly linked to market valuations, so a major fall in asset
prices causes a precipitous decline in revenues relative to costs;
• Above-average fund performance is difficult to sustain, and clients may
not be patient during times of poor performance;
• Successful fund managers are expensive and may be headhunted by
competitors;
• Above-average fund performance appears to be dependent on the unique
skills of the fund manager; however, clients are loath to stake thei
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investments on the ability of a few individuals- they would rather see firm-
wide success, attributable to a single philosophy and internal discipline;
• Analysts who generate above-average returns often become sufficiently
wealthy that they avoid corporate employment in favor of managing their
personal portfolios.
The most successful investment firms in the world have probably been thosethat have been separated physically and psychologically from banks and
insurance companies. That is, the best performance and also the most dynamic
business strategies (in this field) have generally come from independent
investment management firms.
Representing the owners of shares
Institutions often control huge shareholdings. In most cases they are acting asfiduciary agents rather than principals (direct owners). The owners of shares
theoretically have great power to alter the companies they own via the voting
rights the shares carry and the consequent ability to pressure managements
and if necessary out-vote them at annual and other meetings.
In practice, the ultimate owners of shares often do not exercise the power they
collectively hold (because the owners are many, each with small holdings)
financial institutions (as agents) sometimes do. There is a general belief that
shareholders - in this case, the institutions acting as agents—could and should
exercise more active influence over the companies in which they hold shares
(e.g., to hold managers to account, to ensure Boards effective functioning)
Such action would add a pressure group to those (the regulators and the Board
overseeing management.
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However there is the problem of how the institution should exercise this power.
One way is for the institution to decide, the other is for the institution to poll its
beneficiaries. Assuming that the institution polls, should it then: (i) Vote the
entire holding as directed by the majority of votes cast? (ii) Split the vote
(where this is allowed) according to the proportions of the vote? (iii) Or respect
the abstainers and only vote the respondents' holdings?
The price signals generated by large active managers holding or not holding the
stock may contribute to management change. For example, this is the case
when a large active manager sells his position in a company, leading to
(possibly) a decline in the stock price, but more importantly a loss of confidence
by the markets in the management of the company, thus precipitating changes
in the management team.
Some institutions have been more vocal and active in pursuing such matters
for instance, some firms believe that there are investment advantages to
accumulating substantial minority shareholdings (i.e. 10% or more) and putting
pressure on management to implement significant changes in the business. In
some cases, institutions with minority holdings work together to force
management change. Perhaps more frequent is the sustained pressure that
large institutions bring to bear on management teams through persuasive
discourse and PR. On the other hand, some of the largest investment managers—such as Barclays Global Investors and Vanguard—advocate simply owning
every company, reducing the incentive to influence management teams. A
reason for this last strategy is that the investment manager prefers a closer
more open and honest relationship with a company's management team than
would exist if they exercised control; allowing them to make a bette
investment decision.
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The national context in which shareholder representation considerations are set
is variable and important. The USA is a litigious society and shareholders use
the law as a lever to pressure management teams. In Japan it is traditional for
shareholders to be low in the 'pecking order,' which often allows management
and labor to ignore the rights of the ultimate owners. Whereas US firms
generally cater to shareholders, Japanese businesses generally exhibit astakeholder mentality, in which they seek consensus amongst all interested
parties (against a background of strong unions and labour legislation).
Size of the global fund management industry
Assets of the global fund management industry increased for the fourth year
running in 2008 to reach a record $94.3 trillion. This was up 14% on the
previous year and double from five years earlier. Growth during the past three
years has been due to an increase in capital inflows and strong performance of
equity markets.
Pension assets totaled $38.2 trillion in 2008, with a further $26.2 trillion
invested in mutual funds and $19.9 trillion in insurance funds. Together with
alternative assets, such as those of sovereign wealth funds, hedge funds
private equity funds and funds of wealthy individuals, assets of the global fund
management industry probably totaled around $150 trillion at the end of 2008.
The US was by far the largest source of funds under management in 2008 with
nearly a half of the world total. It was followed by the UK with 9% and Japanwith 6%. The Asia-Pacific region has shown the strongest growth in recent
years. Countries such as China and India offer huge potential and many
companies are showing an increased focus in this region.
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Philosophy, process and people
The 3-P's (Philosophy, Process and People) are often used to describe the
reasons why the manager is able to produce above average results.
• Philosophy refers to the over-arching beliefs of the investment
organization. For example: (i) Does the manager buy growth or value
shares (and why)? (ii) Do they believe in market timing (and on what
evidence)? (iii) Do they rely on external research or do they employ a
team of researchers? It is helpful if any and all of such fundamenta
beliefs are supported by proof-statements.
• Process refers to the way in which the overall philosophy is
implemented. For example: (i) Which universe of assets is explored before
particular assets are chosen as suitable investments? (ii) How does the
manager decide what to buy and when? (iii) How does the manager
decide what to sell and when? (iv) Who takes the decisions and are they
taken by committee? (v) What controls are in place to ensure that a rogue
fund (one very different from others and from what is intended) cannot
arise?
• People refer to the staff, especially the fund managers. The questions
are, Who are they? How are they selected? How old are they? Who reports
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to whom? How deep is the team (and do all the members understand the
philosophy and process they are supposed to be using)? And mos
important of all, How long has the team been working together? This last
question is vital because whatever performance record was presented at
the outset of the relationship with the client may or may not relate to
(have been produced by) a team that is still in place. If the team haschanged greatly (high staff turnover or changes to the team), then
arguably the performance record is completely unrelated to the existing
team (of fund managers).
Investment managers and portfolio structures
At the heart of the investment management industry are the managers who
invest and divest client investments.
A certified company investment advisor should conduct an assessment of each
client's individual needs and risk profile. The advisor then recommends
appropriate investments.
Asset allocation
The different asset class definitions are widely debated, but four common
divisions are stocks, bonds, real-estate and commodities. The exercise o
allocating funds among these assets (and among individual securities within
each asset class) is what investment management firms are paid for. Asset
classes exhibit different market dynamics, and different interaction effects
thus, the allocation of monies among asset classes will have a significant effect
on the performance of the fund. Some research suggests that allocation among
asset classes has more predictive power than the choice of individual holdings
in determining portfolio return. Arguably, the skill of a successful investment
manager resides in constructing the asset allocation, and separately the
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individual holdings, so as to outperform certain benchmarks (e.g., the peer
group of competing funds, bond and stock indices).
Long-term returns
It is important to look at the evidence on the long-term returns to different
assets, and to holding period returns (the returns that accrue on average over
different lengths of investment). For example, over very long holding periods
(eg. 10+ years) in most countries, equities have generated higher returns than
bonds, and bonds have generated higher returns than cash. According to
financial theory, this is because equities are riskier (more volatile) than bonds
which are themselves more risky than cash.
Diversification
Against the background of the asset allocation, fund managers consider the
degree of diversification that makes sense for a given client (given its riskpreferences) and construct a list of planned holdings accordingly. The list wil
indicate what percentage of the fund should be invested in each particular stock
or bond. The theory of portfolio diversification was originated by Markowitz and
effective diversification requires management of the correlation between the
asset returns and the liability returns, issues internal to the portfolio (individua
holdings volatility), and cross-correlations between the returns.
Investment styles
There are a range of different styles of fund management that the institution
can implement. For example, growth, value, market neutral, smal
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capitalization, indexed, etc. Each of these approaches has its distinctive
features, adherents and, in any particular financial environment, distinctive risk
characteristics. For example, there is evidence that growth styles (buying
rapidly growing earnings) are especially effective when the companies able to
generate such growth are scarce; conversely, when such growth is plentiful
then there is evidence that value styles tend to outperform the indicesparticularly successfully.
Performance measurement
Fund performance is the acid test of fund management, and in the institutiona
context accurate measurement is a necessity. For that purpose, institutions
measure the performance of each fund (and usually for internal purposes
components of each fund) under their management, and performance is also
measured by external firms that specialize in performance measurement
In a typical case (let us say an equity fund), then the calculation would be made
(as far as the client is concerned) every quarter and would show a percentage
change compared with the prior quarter (e.g., +4.6% total return in US dollars)
This figure would be compared with other similar funds managed within the
institution (for purposes of monitoring internal controls), with performance data
for peer group funds, and with relevant indices (where available) or tailor-made
performance benchmarks where appropriate. The specialist performance
measurement firms calculate quartile and docile data and close attention would
be paid to the (percentile) ranking of any fund.
Generally speaking, it is probably appropriate for an investment firm to
persuade its clients to assess performance over longer periods (e.g., 3 to 5
years) to smooth out very short term fluctuations in performance and the
influence of the business cycle. This can be difficult however and, industry wide
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there is a serious preoccupation with short-term numbers and the effect on the
relationship with clients (and resultant business risks for the institutions).
An enduring problem is whether to measure before-tax or after-tax
performance. After-tax measurement represents the benefit to the investor, but
investors' tax positions may vary. Before-tax measurement can be misleading
especially in regimens that tax realized capital gains (and not unrealized). It is
thus possible that successful active managers (measured before tax) may
produce miserable after-tax results. One possible solution is to report the after-
tax position of some standard taxpayer.
Risk-adjusted performance measurement
Performance measurement should not be reduced to the evaluation of fund
returns alone, but must also integrate other fund elements that would be of
interest to investors, such as the measure of risk taken. Several other aspects
are also part of performance measurement: evaluating if managers have
succeeded in reaching their objective, i.e. if their return was sufficiently high toreward the risks taken; how they compare to their peers; and finally whether
the portfolio management results were due to luck or the manager’s skill. The
need to answer all these questions has led to the development of more
sophisticated performance measures, many of which originate in modern
portfolio theory.
Modern portfolio theory established the quantitative link that exists between
portfolio risk and return. The Capital Asset Pricing Model (CAPM) developed by
Sharpe (1964) highlighted the notion of rewarding risk and produced the first
performance indicators, be they risk-adjusted ratios (Sharpe ratio, information
ratio) or differential returns compared to benchmarks (alphas). The Sharpe ratio
is the simplest and best known performance measure. It measures the return of
a portfolio in excess of the risk-free rate, compared to the total risk of the
portfolio. This measure is said to be absolute, as it does not refer to any
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benchmark, avoiding drawbacks related to a poor choice of benchmark
Meanwhile, it does not allow the separation of the performance of the market in
which the portfolio is invested from that of the manager. The information ratio
is a more general form of the Sharpe ratio in which the risk-free asset is
replaced by a benchmark portfolio. This measure is relative, as it evaluates
portfolio performance in reference to a benchmark, making the result stronglydependent on this benchmark choice.
Portfolio alpha is obtained by measuring the difference between the return of
the portfolio and that of a benchmark portfolio. This measure appears to be the
only reliable performance measure to evaluate active management. In fact, wehave to distinguish between normal returns, provided by the fair reward for
portfolio exposure to different risks, and obtained through passive
management, from abnormal performance (or out performance) due to the
manager’s skill, whether through market timing or stock picking. The first
component is related to allocation and style investment choices, which may not
be under the sole control of the manager, and depends on the economic
context, while the second component is an evaluation of the success of the
manager’s decisions. Only the latter, measured by alpha, allows the evaluation
of the manager’s true performance.
Portfolio normal return may be evaluated using factor models. The first model
proposed by Jensen (1968), relies on the CAPM and explains portfolio norma
returns with the market index as the only factor. It quickly becomes clear,
however, that one factor is not enough to explain the returns and that other
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factors have to be considered. Multi-factor models were developed as an
alternative to the CAPM, allowing a better description of portfolio risks and an
accurate evaluation of managers’ performance. For example, Fama and French
(1993) have highlighted two important factors that characterize a company's
risk in addition to market risk. These factors are the book-to-market ratio and
the company's size as measured by its market capitalization. Fama and Frenchtherefore proposed a three-factor model to describe portfolio normal returns
(Fama-French three-factor model). Carhart (1997) proposed to add momentum
as a fourth factor to allow the persistence of the returns to be taken into
account. Also of interest for performance measurement is Sharpe’s (1992) style
analysis model, in which factors are style indices. This model allows a custom
benchmark for each portfolio to be developed, using the linear combination of
style indices that best replicate portfolio style allocation, and leads to an
accurate evaluation of portfolio alpha.
Security
A security is a fungible, negotiable instrument representing financial value
Securities are broadly categorized into debt securities (such as banknotes
bonds and debentures); equity securities, e.g., common stocks; and derivative
(finance) contracts such as forwards, futures, options and swaps. The company
or other entity issuing the security is called the issuer. What specifically
qualifies as a security is dependent on the regulatory structure in a country. For
example, private investment pools may have some features of securities, but
they may not be registered or regulated as such if they meet various
restrictions.
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Securities may be represented by a certificate or, more typically, "non-
certificated", that is in electronic or "book entry" only form. Certificates may be
bearer, meaning they entitle the holder to rights under the security merely by
holding the security, or registered, meaning they entitle the holder to rights
only if he or she appears on a security register maintained by the issuer or an
intermediary. They include shares of corporate stock or mutual funds, bonds
issued by corporations or governmental agencies, stock options or other
options, limited partnership units, and various other formal investment
instruments that are negotiable and fungible.
Classification of Securities
Securities may be classified according to many categories or classification
systems:
• Issuer
• Currency of denomination
• Ownership rights
• Term to maturity
• Degree of liquidity
• Income payments
• Tax treatment
• Credit Rating
• Industrial Sector or "Industry" (Sector often refers to a higher level or
broader category such as Consumer Discretionary whereas Industry often
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refers to a lower level classification such as Consumer Appliances; See
Industry for a discussion of some classification systems).
• Region or Country (such as country of incorporation, country of principal
sales/market of its products or services, or country in which the principa
securities exchange on which it trades is located)
• Market Capitalization
• State (typically for municipal or "tax-free" bonds in the India)
By type of issuer
Issuers of securities include commercial companies, government agencies, loca
authorities and international and supranational organizations (such as the World
Bank). Debt securities issued by a government (called government bonds or
sovereign bonds) generally carry a lower interest rate than corporate debt
issued by commercial companies. Interests in an asset—for example, the flow of
royalty payments from intellectual property—may also be turned into securities These repackaged securities resulting from a securitization are usually issued
by a company established for the purpose of the repackaging—called a specia
purpose vehicle (SPV). See "Repackaging" below. SPVs are also used to issue
other kinds of securities. SPVs can also be used to guarantee securities, such as
covered bonds.
New capital
Commercial enterprises have traditionally used securities as a means of raising
new capital. Securities may be an attractive option relative to bank loans
depending on their pricing and market demand for particular characteristics.
Another disadvantage of bank loans as a source of financing is that the bank
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may seek a measure of protection against default by the borrower via extensive
financial covenants. Through securities, capital is provided by investors who
purchase the securities upon their initial issuance. In a similar way, the
governments may raise capital through the issuance of securities (see
government debt).
Repackaging
In recent decades securities have been issued to repackage existing assets. In a
traditional securitization, a financial institution may wish to remove assets from
its balance sheet in order to achieve regulatory capital efficiencies or toaccelerate its receipt of cash flow from the original assets. Alternatively, an
intermediary may wish to make a profit by acquiring financial assets and
repackaging them in a way which makes them more attractive to investors. In
other words, a basket of assets is typically contributed or placed into a separate
legal entity such as a trust or SPV, which subsequently issues shares of equity
interest to investors. This allows the sponsor entity to more easily raise capita
for these assets as opposed to finding buyers to purchase directly such assets.
By type of holder
Investors in securities may be retail, i.e. members of the public investing other
than by way of business. The greatest part in terms of volume of investment is
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wholesale, i.e. by financial institutions acting on their own account, or on behalf
of clients. Important institutional investors include investment banks, insurance
companies, pension funds and other managed funds.
Investment
The traditional economic function of the purchase of securities is investment
with the view to receiving income and/or achieving capital gain. Debt securities
generally offer a higher rate of interest than bank deposits, and equities may
offer the prospect of capital growth. Equity investment may also offer control of
the business of the issuer. Debt holdings may also offer some measure o
control to the investor if the company is a fledgling start-up or an old giant
undergoing 'restructuring'. In these cases, if interest payments are missed, the
creditors may take control of the company and liquidate it to recover some of
their investment.
Collateral
The last decade has seen an enormous growth in the use of securities as
collateral. Purchasing securities with borrowed money secured by other
securities or cash itself is called "buying on margin." Where A is owed a debt or
other obligation by B, A may require B to deliver property rights in securities to
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A. These property rights enable A to satisfy its claims in the event that B fails to
make good on its obligations to A or otherwise becomes insolvent. Collatera
arrangements are divided into two broad categories, namely security interests
and outright collateral transfers. Commonly, commercial banks, investment
banks, government agencies and other institutional investors such as mutua
funds are significant collateral takers or providers. In addition, private partiesincluding funds and small institutions may utilize stocks or other securities as
collateral for portfolio loans in securities lending scenarios, which may be
structured into either recourse or nonrecourse packages and are often referred
to as "hedge loans".
Debt and equity
Securities are traditionally divided into debt securities and equities.
Debt
Debt securities may be called debentures, bonds, deposits, notes or
commercial paper depending on their maturity and certain other
characteristics. The holder of a debt security is typically entitled to the
payment of principal and interest, together with other contractual rights
under the terms of the issue, such as the right to receive certain information
Debt securities are generally issued for a fixed term and redeemable by the
issuer at the end of that term. Debt securities may be protected by collatera
or may be unsecured, and, if they are unsecured, may be contractually
"senior" to other unsecured debt meaning their holders would have a priority
in a bankruptcy of the issuer. Debt that is not senior is "subordinated".
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Corporate bonds represent the debt of commercial or industrial entities
Debentures have a long maturity, typically at least ten years, whereas notes
have a shorter maturity. Commercial paper is a simple form of debt security
that essentially represents a post-dated check with a maturity of not more
than 270 days.
Money market instruments are short term debt instruments that
may have characteristics of deposit accounts, such as certificates of deposit
and certain bills of exchange. They are highly liquid and are sometimes
referred to as "near cash". Commercial paper is also often highly liquid.
Euro debt securities are securities issued internationally outside theidomestic market in a denomination different from that of the issuer's
domicile. They include Eurobonds and Euro notes. Eurobonds are
characteristically underwritten, and not secured, and interest is paid gross. A
Euro note may take the form of euro-commercial paper (ECP) or euro-
certificates of deposit.
Government bonds are medium or long term debt securities issued by
sovereign governments or their agencies. Typically they carry a lower rate of
interest than corporate bonds, and serve as a source of finance for
governments. U.S. federal government bonds are called treasuries. Because
of their liquidity and perceived low risk, treasuries are used to manage the
money supply in the open market operations of non-US central banks.
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Sub-sovereign government bonds, known in the India as municipa
bonds, represent the debt of state, provincial, territorial, municipal or other
governmental units other than sovereign governments.
Supranational bonds represent the debt of international organizations
such as the World Bank, the International Monetary Fund, regiona
multilateral development banks and others.
Equity
An equity security is a share of equity interest in an entity such as the capita
stock of a company, trust or partnership. The most common form of equity
interest is common stock, although preferred equity is also a form of capita
stock. The holder of an equity is a shareholder, owning a share, or fractiona
part of the issuer. Unlike debt securities, which typically require regula
payments (interest) to the holder, equity securities are not entitled to any
payment. In bankruptcy, they share only in the residual interest of the issuer
after all obligations have been paid out to creditors. However, equity
generally entitles the holder to a pro rata portion of control of the company,
meaning that a holder of a majority of the equity is usually entitled to control
the issuer. Equity also enjoys the right to profits and capital gain, whereas
holders of debt securities receive only interest and repayment of principa
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regardless of how well the issuer performs financially. Furthermore, deb
securities do not have voting rights outside of bankruptcy. In other words
equity holders are entitled to the "upside" of the business and to control the
business
• Stock
Hybrid
Hybrid securities combine some of the characteristics of both debt and equity
securities.
Preference shares form an intermediate class of security between equities
and debt. If the issuer is liquidated, they carry the right to receive interest
and/or a return of capital in priority to ordinary shareholders. However, from a
legal perspective, they are capital stock and therefore may entitle holders to
some degree of control depending on whether they contain voting rights.
Convertibles are bonds or preferred stock which can be converted, at the
election of the holder of the convertibles, into the common stock of the issuing
company. The convertibility, however, may be forced if the convertible is a
callable bond, and the issuer calls the bond. The bondholder has about 1 month
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to convert it, or the company will call the bond by giving the holder the call
price, which may be less than the value of the converted stock. This is referred
to as a forced conversion.
Equity warrants are options issued by the company that allow the holder of
the warrant to purchase a specific number of shares at a specified price within a
specified time. They are often issued together with bonds or existing equities
and are, sometimes, detachable from them and separately tradable. When the
holder of the warrant exercises it, he pays the money directly to the company,
and the company issues new shares to the holder.
Warrants, like other convertible securities, increases the number of shares
outstanding, and are always accounted for in financial reports as fully diluted
earnings per share, which assumes that all warrants and convertibles will beexercised.
The securities markets
Primary and secondary market
In the U.S., the public securities markets can be divided into primary and
secondary markets. The distinguishing difference between the two markets is
that in the primary market, the money for the securities is received by the
issuer of those securities from investors, typically in an initial public offering
transaction, whereas in the secondary market, the securities are simply assets
held by one investor selling them to another investor (money goes from one
investor to the other). An initial public offering is when a company issues public
stock newly to investors, called an "IPO" for short. A company can later issue
more new shares, or issue shares that have been previously registered in a
shelf registration. These later new issues are also sold in the primary market
but they are not considered to be an IPO but are often called a "secondary
offering". Issuers usually retain investment banks to assist them in
administering the IPO, obtaining SEC (or other regulatory body) approval of the
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offering filing, and selling the new issue. When the investment bank buys the
entire new issue from the issuer at a discount to resell it at a markup, it is called
a firm commitment underwriting. However, if the investment bank considers the
risk too great for an underwriting, it may only assent to a best effort agreement
where the investment bank will simply do its best to sell the new issue.
In order for the primary market to thrive, there must be a secondary market, or
aftermarket which provides liquidity for the investment security, where holders
of securities can sell them to other investors for cash. Otherwise, few people
would purchase primary issues, and, thus, companies and governments would
be restricted in raising equity capital (money) for their operations. Organized
exchanges constitute the main secondary markets. Many smaller issues and
most debt securities trade in the decentralized, dealer-based over-the-counter
markets.
Public offer and private placement
In the primary markets, securities may be offered to the public in a public offer
Alternatively, they may be offered privately to a limited number of qualified
persons in a private placement. Sometimes a combination of the two is used
The distinction between the two is important to securities regulation and
company law. Privately placed securities are not publicly tradable and may only
be bought and sold by sophisticated qualified investors. As a result, the
secondary market is not nearly as liquid as it is for public (registered) securities.
Another category, sovereign debt, is generally sold by auction to a specialized
class of dealers.
Listing and OTC dealing
Securities are often listed in a stock exchange, an organized and officially
recognized market on which securities can be bought and sold. Issuers may
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seek listings for their securities in order to attract investors, by ensuring that
there is a liquid and regulated market in which investors will be able to buy and
sell securities.
Growth in informal electronic trading systems has challenged the traditiona
business of stock exchanges. Large volumes of securities are also bought and
sold "over the counter" (OTC). OTC dealing involves buyers and sellers dealing
with each other by telephone or electronically on the basis of prices that are
displayed electronically, usually by commercial information vendors such as
Reuters and Bloomberg.
There are also eurosecurities, which are securities that are issued outside thei
domestic market into more than one jurisdiction. They are generally listed on
the Luxembourg Stock Exchange or admitted to listing in London. The reasonsfor listing eurobonds include regulatory and tax considerations, as well as the
investment restrictions.
Market
London is the centre of the eurosecurities markets. There was a huge rise in the
eurosecurities market in London in the early 1980s. Settlement of trades in
eurosecurities is currently effected through two European computerized
clearing/depositories called Euroclear (in Belgium) and Clearstream (formerly
Cedelbank) in Luxembourg.
The main market for Eurobonds is the EuroMTS, owned by Borsa Italiana and
Euronext. There are ramp up market in Emergent countries, but it is growing
slowly.
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Physical nature of securities
Certificated securities
Securities that are represented in paper (physical) form are called certificated
securities. They may be bearer or registered .
Bearer securities
Bearer securities are completely negotiable and entitle the holder to the rights
under the security (e.g. to payment if it is a debt security, and voting if it is an
equity security). They are transferred by delivering the instrument from person
to person. In some cases, transfer is by endorsement, or signing the back of the
instrument, and delivery.
Regulatory and fiscal authorities sometimes regard bearer securities negatively
as they may be used to facilitate the evasion of regulatory restrictions and tax
In the United Kingdom, for example, the issue of bearer securities was heavily
restricted firstly by the Exchange Control Act 1947 until 1953. Bearer securities
are very rare in the United States because of the negative tax implications they
may have to the issuer and holder.
Registered securities
In the case of registered securities, certificates bearing the name of the holder
are issued, but these merely represent the securities. A person does not
automatically acquire legal ownership by having possession of the certificate
Instead, the issuer (or its appointed agent) maintains a register in which details
of the holder of the securities are entered and updated as appropriate. A
transfer of registered securities is effected by amending the register.
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Non-certificated securities and global certificates
Modern practice has developed to eliminate both the need for certificates and
maintenance of a complete security register by the issuer. There are two
general ways this has been accomplished.
Non-certificated securities
In some jurisdictions, such as France, it is possible for issuers of that jurisdiction
to maintain a legal record of their securities electronically.
In the United States, the current "official" version of Article 8 of the Uniform
Commercial Code permits non-certificated securities. However, the "official"
UCC is a mere draft that must be enacted individually by each of the U.S
states. Though all 50 states (as well as the District of Columbia and the U.SVirgin Islands) have enacted some form of Article 8, many of them still appear
to use older versions of Article 8, including some that did not permit non
certificated securities. [1]
In the U.S. today, most mutual funds issue only non-certificated shares to
shareholders, though some may issue certificates only upon request and may
charge a fee. Shareholders typically don't need certificates except for perhaps
pledging such shares as collateral for a loan.
Global certificates, book entry interests, depositories
In order to facilitate the electronic transfer of interests in securities without
dealing with inconsistent versions of Article 8, a system has developed wherebyissuers deposit a single global certificate representing all the outstanding
securities of a class or series with a universal depository. This depository is
called The Depository Trust Company, or DTC. DTC's parent, Depository Trust &
Clearing Corporation (DTCC), is a non-profit cooperative owned by
approximately thirty of the largest Wall Street players that typically act as
brokers or dealers in securities. These thirty banks are called the DTC
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participants. DTC, through a legal nominee, owns each of the global securities
on behalf of all the DTC participants.
All securities traded through DTC are in fact held, in electronic form, on the
books of various intermediaries between the ultimate owner, e.g. a retai
investor, and the DTC participants. For example, Mr. Smith may hold 100 shares
of Coca Cola, Inc. in his brokerage account at local broker Jones & Co. brokers
In turn, Jones & Co. may hold 1000 shares of Coca Cola on behalf of Mr. Smith
and nine other customers. These 1000 shares are held by Jones & Co. in an
account with Goldman Sachs, a DTC participant, or in an account at another
DTC participant. Goldman Sachs in turn may hold millions of Coca Cola shares
on its books on behalf of hundreds of brokers similar to Jones & Co. Each day
the DTC participants settle their accounts with the other DTC participants and
adjust the number of shares held on their books for the benefit of customers
like Jones & Co. Ownership of securities in this fashion is called beneficia
ownership. Each intermediary holds on behalf of someone beneath him in the
chain. The ultimate owner is called the beneficial owner. This is also referred to
as owning in "Street name".
Among brokerages and mutual fund companies, a large amount of mutual fund
share transactions take place among intermediaries as opposed to shares being
sold and redeemed directly with the transfer agent of the fund. Most of these
intermediaries such as brokerage firms clear the shares electronically through
the National Securities Clearing Corp. or "NSCC", a subsidiary of DTCC.
Other depositories: Euroclear and Clearstream
Besides DTC, two other large securities depositories exist, both in Europe
Euroclear and Clearstream.
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Divided and undivided security
The terms "divided" and "undivided" relate to the proprietary nature of a
security.
Each divided security constitutes a separate asset, which is legally distinct from
each other security in the same issue. Pre-electronic bearer securities were
divided. Each instrument constitutes the separate covenant of the issuer and is
a separate debt.
With undivided securities, the entire issue makes up one single asset, with each
of the securities being a fractional part of this undivided whole. Shares in the
secondary markets are always undivided. The issuer owes only one set o
obligations to shareholders under its memorandum, articles of association and
company law. A share represents an undivided fractional part of the issuing
company. Registered debt securities also have this undivided nature.
Fungible and non-fungible security
The terms "fungible" and "non-fungible" relate to the way in which securities
are held.
If an asset is fungible, this means that if such an asset is lent, or placed with acustodian, it is customary for the borrower or custodian to be obliged at the end
of the loan or custody arrangement to return assets equivalent to the origina
asset, rather than the specific identical asset. In other words, the redelivery of
fungibles is equivalent and not in specie. In other words, if an owner of 100
shares of IBM transfers custody of those shares to another party to hold them
for a purpose, at the end of the arrangement, the holder need
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simply provide the owner with 100 shares of IBM which are identical to that
received. Cash is also an example of a fungible asset. The exact currency notes
received need not be segregated and returned to the owner.
Undivided securities are always fungible by logical necessity. Divided securities
may or may not be fungible, depending on market practice. The clear trend is
towards fungible arrangements.
In economics, a financial market is a mechanism that allows people to easily
buy and sell (trade) financial securities (such as stocks and bonds)
commodities (such as precious metals or agricultural goods), and other fungible
items of value at low transaction costs and at prices that reflect the efficient-
market hypothesis.
Financial markets have evolved significantly over several hundred years and
are undergoing constant innovation to improve liquidity.
Both general markets (where many commodities are traded) and specialized
markets (where only one commodity is traded) exist. Markets work by placing
many interested buyers and sellers in one "place", thus making it easier for
them to find each other. An economy which relies primarily on interactions
between buyers and sellers to allocate resources is known as a marketeconomy in contrast either to a command economy or to a non-market
economy such as a gift economy.
In finance, financial markets facilitate –
• The raising of capital (in the capital markets);
• The transfer of risk (in the derivatives markets);
• International trade (in the currency markets)
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– and are used to match those who want capital to those who have it.
Typically a borrower issues a receipt to the lender promising to pay back the
capital. These receipts are securities which may be freely bought or sold. In
return for lending money to the borrower, the lender will expect some
compensation in the form of interest or dividends.
In economics, typically, the term market means the aggregate of possible
buyers and sellers of a thing and the transactions between them.
The term "market" is sometimes used for what are more strictly exchanges
organizations that facilitate the trade in financial securities, e.g., a stock
exchange or commodity exchange. This may be a physical location (like the
NYSE) or an electronic system (like NASDAQ). Much trading of stocks takes
place on an exchange; still, corporate actions (merger, spinoff) are outside an
exchange, while any two companies or people, for whatever reason, may agree
to sell stock from the one to the other without using an exchange.
Trading of currencies and bonds is largely on a bilateral basis, although some
bonds trade on a stock exchange, and people are building electronic systems
for these as well, similar to stock exchanges.
Financial markets can be domestic or they can be international.
Types of financial markets
The financial markets can be divided into different subtypes:
• Capital markets which consist of:
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o Stock markets, which provide financing through the issuance of
shares or common stock, and enable the subsequent trading
thereof.
o Bond markets, which provide financing through the issuance of
bonds, and enable the subsequent trading thereof.
•
Commodity markets, which facilitate the trading of commodities.• Money markets, which provide short term debt financing and investment.
• Derivatives markets, which provide instruments for the management of
financial risk.
o Futures markets, which provide standardized forward contracts for
trading products at some future date; see also forward market.
• Insurance markets, which facilitate the redistribution of various risks.
• Foreign exchange markets, which facilitate the trading of foreign
exchange.
The capital markets consist of primary markets and secondary markets. Newly
formed (issued) securities are bought or sold in primary markets. Secondary
markets allow investors to sell securities that they hold or buy existing
securities.
Raising capital
To understand financial markets, let us look at what they are used for, i.e. what
is their purpose?
Without financial markets, borrowers would have difficulty finding lenders
themselves. Intermediaries such as banks help in this process. Banks take
deposits from those who have money to save. They can then lend money from
this pool of deposited money to those who seek to borrow. Banks popularly lend
money in the form of loans and mortgages.
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Lenders
Individuals
Many individuals are not aware that they are lenders, but almost everybody
does lend money in many ways. A person lends money when he or she:
• puts money in a savings account at a bank;
• contributes to a pension plan;
• pays premiums to an insurance company;
• invests in government bonds; or
• invests in company shares.
Companies
Companies tend to be borrowers of capital. When companies have surplus cash
that is not needed for a short period of time, they may seek to make money
from their cash surplus by lending it via short term markets called money
markets.
There are a few companies that have very strong cash flows. These companies
tend to be lenders rather than borrowers. Such companies may decide to return
cash to lenders (e.g. via a share buyback.) Alternatively, they may seek to make
more money on their cash by lending it (e.g. investing in bonds and stocks.)
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Borrowers
Individuals borrow money via bankers' loans for short term needs or longer
term mortgages to help finance a house purchase.
Companies borrow money to aid short term or long term cash flows. They also
borrow to fund modernisation or future business expansion.
Governments often find their spending requirements exceed their tax revenues
To make up this difference, they need to borrow. Governments also borrow on
behalf of nationalised industries, municipalities, local authorities and othe
public sector bodies. In the UK, the total borrowing requirement is often referred
to as the Public sector net cash requirement (PSNCR).
Governments borrow by issuing bonds. In the UK, the government also borrows
from individuals by offering bank accounts and Premium Bonds. Government
debt seems to be permanent. Indeed the debt seemingly expands rather than
being paid off. One strategy used by governments to reduce the value of the
debt is to influence inflation.
Municipalities and local authorities may borrow in their own name as well as
receiving funding from national governments. In the UK, this would cover an
authority like Hampshire County Council.
Public Corporations typically include nationalised industries. These may include
the postal services, railway companies and utility companies.
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Many borrowers have difficulty raising money locally. They need to borrow
internationally with the aid of Foreign exchange markets.
Derivative products
During the 1980s and 1990s, a major growth sector in financial markets is the
trade in so called derivative products, or derivatives for short.
In the financial markets, stock prices, bond prices, currency rates, interest rates
and dividends go up and down, creating risk . Derivative products are financia
products which are used to control risk or paradoxically exploit risk. It is also
called financial economics.
Currency markets
Seemingly, the most obvious buyers and sellers of foreign exchange are
importers/exporters. While this may have been true in the distant past, whereby
importers/exporters created the initial demand for currency markets, importers
and exporters now represent only 1/32 of foreign exchange dealing, according
to BIS.[1]
The picture of foreign currency transactions today shows:
• Banks/Institutions
• Speculators
• Government spending (for example, military bases abroad)
• Importers/Exporters
• Tourists
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Analysis of financial markets
Much effort has gone into the study of financial markets and how prices vary
with time. Charles Dow, one of the founders of Dow Jones & Company and The
Wall Street Journal, enunciated a set of ideas on the subject which are now
called Dow Theory. This is the basis of the so-called technical analysis methodof attempting to predict future changes. One of the tenets of "technica
analysis" is that market trends give an indication of the future, at least in the
short term. The claims of the technical analysts are disputed by many
academics, who claim that the evidence points rather to the random walk
hypothesis, which states that the next change is not correlated to the last
change.
The scale of changes in price over some unit of time is called the volatility. It
was discovered by Benoît Mandelbrot that changes in prices do not follow a
Gaussian distribution, but are rather modeled better by Lévy stable
distributions. The scale of change, or volatility, depends on the length of the
time unit to a power a bit more than 1/2. Large changes up or down are more
likely than what one would calculate using a Gaussian distribution with an
estimated standard deviation.
Financial markets in popular culture
Only negative stories about financial markets tend to make the news. The
general perception, for those not involved in the world of financial markets is of
a place full of crooks and con artists. Big stories like the Enron scandal serve to
enhance this view.
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Stories that make the headlines involve the incompetent, the lucky and the
downright skillful. The Barings scandal is a classic story of incompetence mixed
with greed leading to dire consequences. Another story of note is that of Black
Wednesday, when sterling came under attack from hedge fund speculators
This led to major problems for the United Kingdom and had a serious impact on
its course in Europe. A commonly recurring event is the stock market bubblewhereby market prices rise to dizzying heights in a so called exaggerated bul
market. This is not a new phenomenon; indeed the story of Tulip mania in the
Netherlands in the 17th century illustrates an early recorded example.
Financial markets are merely tools. Like all tools they have both beneficial and
harmful uses. Overall, financial markets are used by honest people. Otherwise
people would turn away from them en masse. As in other walks of life, the
financial markets have their fair share of rogue elements.
Financial market slang
• Geek , a Quant
• Grim, an ageless person known for his/her whistle and tendency to relate
current events to financial market
• Nerd, a Quant
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• Quant, a quantitative analyst skilled in the black arts of PhD level (and
above) mathematics and statistical methods
• Rocket scientist, a financial consultant at the zenith of mathematica
and computer programming skill. They are able to invent derivatives of
frightening complexity and construct sophisticated pricing models. They
generally handle the most advanced computing techniques adopted bythe financial markets since the early 1980s. Typically, they are physicists
and engineers by training; rocket scientists do not necessarily build
rockets for a living.
• White Knight, a friendly party in a takeover bid. Used to describe a party
that buys the shares of an organization to help prevent the takeover of
that organization by another party (that is making a hostile bid).
• Poison pill, measures taken by a company to prevent being bought out
by another company
Financial instrument
Financial instruments are cash, evidence of an ownership
interest in an entity, or a c Categorization
Financial instruments can be categorized by form depending on whether they
are cash instruments or derivative instruments:
• Cash instruments are financial instruments whose value is determined
directly by markets. They can be divided into securities, which are readily
transferable, and other cash instruments such as loans and deposits
where both borrower and lender have to agree on a transfer.
• Derivative instruments are financial instruments which derive their
value from the value and characteristics of one or more underlying assets
They can be divided into exchange-traded derivatives and over-the
counter (OTC) derivatives.
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Alternatively, financial instruments can be categorized by "asset class
depending on whether they are equity based (reflecting ownership of the
issuing entity) or debt based (reflecting a loan the investor has made to the
issuing entity). If it is debt, it can be further categorised into short term (less
than one year) or long term.
Foreign Exchange instruments and transactions are neither debt nor equity
based and belong in their own category.
Measuring Financial Instrument's Gain or Loss
The table below shows how to measure a financial instrument's gain or loss:
Instrument
Type Categories Measurement Gains and losses
AssetsLoans and
receivablesAmortized costs
Net income when asset i
derecognized or impaired (foreignexchange and impairmen
recognized in net income
immediately)
Assets
Available for
sale financial
assets
Deposit account
- Fair value
Other comprehensive income
(impairment recognized in ne
income immediately)
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Contractual right to receive, or deliver, cash or another financial instrument.
Investment theory
Investment theory encompasses the body of knowledge used to support the
decision-making process of choosing investments for various purposes. I
includes portfolio theory, the Capital Asset Pricing Model, Arbitrage Pricing
Theory, and the Efficient market hypothesis.
Modern portfolio theory
Modern portfolio theory (MPT) proposes how rational investors will use
diversification to optimize their portfolios, and how a risky asset should be
priced. The basic concepts of the theory are Markowitz diversification, the
efficient frontier, capital asset pricing model, the alpha and beta coefficients
the Capital Market Line and the Securities Market Line.
MPT models an asset's return as a random variable, and models a portfolio as a
weighted combination of assets so that the return of a portfolio is the weighted
combination of the assets' returns. Moreover, a portfolio's return is a random
variable, and consequently has an expected value and a variance. Risk, in this
model, is the standard deviation of return.
Risk and return
The model assumes that investors are risk averse, meaning that given two
assets that offer the same expected return, investors will prefer the less risky
one. Thus, an investor will take on increased risk only if compensated by higher
expected returns. Conversely, an investor who wants higher returns must
accept more risk. The exact trade-off will differ by investor based on individual
risk aversion characteristics. The implication is that a rational investor will not
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invest in a portfolio if a second portfolio exists with a more favorable risk-return
profile – i.e., if for that level of risk an alternative portfolio exists which has
better expected returns.
Mean and variance
It is further assumed that investor's risk / reward preference can be described
via a quadratic utility function. The effect of this assumption is that only the
expected return and the volatility (i.e., mean return and standard deviation)
matter to the investor. The investor is indifferent to other characteristics of the
distribution of returns, such as its skew (measures the level of asymmetry in the
distribution) or kurtosis (measure of the thickness or so-called "fat tail").
Note that the theory uses a parameter, volatility, as a proxy for risk, while
return is an expectation on the future. This is in line with the efficient market
hypothesis and most of the classical findings in finance such as Black and
Scholes European Option Pricing (martingale measure: in short means that the
best forecast for tomorrow is the price of today). Recent innovations in portfolio
theory, particularly under the rubric of Post-Modern Portfolio Theory (PMPT),
have exposed several flaws in this reliance on variance as the investor's risk
proxy:
• The theory uses a historical parameter, volatility, as a proxy for risk, while
return is an expectation on the future. (It is noted though that this is in
line with the Efficiency Hypothesis and most of the classical findings in
finance such as Black and Scholes which make use of the martingalemeasure, i.e. the assumption that the best forecast for tomorrow is the
price of today).
• The statement that "the investor is indifferent to other characteristics"
seems not to be true given that skewness risk appears to be priced by the
market[citation needed ].
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Under the model:
• Portfolio return is the proportion-weighted combination of the constituent
assets' returns.
• Portfolio volatility is a function of the correlation ρ of the component
assets. The change in volatility is non-linear as the weighting of the
component assets changes.
Diversification
An investor can reduce portfolio risk simply by holding combinations o
instruments which are not perfectly positively correlated (correlation coefficient
-1<(r)<0)). In other words, investors can reduce their exposure to individua
asset risk by holding a diversified portfolio of assets. Diversification will allow for
the same portfolio return with reduced risk.
If all the assets of a portfolio have a correlation of +1, i.e., perfect positive
correlation, the portfolio volatility (standard deviation) will be equal to the
weighted sum of the individual asset volatilities. Hence the portfolio variance
will be equal to the square of the total weighted sum of the individual asset
volatilities.
If all the assets have a correlation of 0, i.e., perfectly uncorrelated, the portfolio
variance is the sum of the individual asset weights squared times the individua
asset variance (and volatility is the square root of this sum).
If correlation coefficient is less than zero (r=0), i.e., the assets are inversely
correlated, the portfolio variance and hence volatility will be less than if the
correlation coefficient is 0.
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Capital allocation line
The capital allocation line (CAL) is the line of expected return plotted against
risk (standard deviation) that connects all portfolios that can be formed using a
risky asset and a riskless asset. It can be proven that it is a straight line and
that it has the following equation.
In this formula P is the risky portfolio, F is the riskless portfolio, and C is a
combination of portfolios P and F .
The efficient frontier
Efficient Frontier. The hyperbola is sometimes referred to as the 'Markowitz
Bullet'
Every possible asset combination can be plotted in risk-return space, and the
collection of all such possible portfolios defines a region in this space. The line
along the upper edge of this region is known as the efficient frontier (sometimes
"the Markowitz frontier"). Combinations along this line represent portfolios
(explicitly excluding the risk-free alternative) for which there is lowest risk for a
given level of return. Conversely, for a given amount of risk, the portfolio lying
on the efficient frontier represents the combination offering the best possible
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return. Mathematically the Efficient Frontier is the intersection of the Set of
Portfolios with Minimum Variance (MVS) and the Set of Portfolios with Maximum
Return. Formally, the efficient frontier is the set of maximal elements with
respect to the partial order of product order on risk and return, the set of
portfolios for which one cannot improve both risk and return.
The efficient frontier will be convex – this is because the risk-retur
characteristics of a portfolio change in a non-linear fashion as its component
weightings are changed. (As described above, portfolio risk is a function of the
correlation of the component assets, and thus changes in a non-linear fashion
as the weighting of component assets changes.) The
efficient frontier is a parabola (hyperbola) when expected return is plotted
against variance (standard deviation).
The region above the frontier is unachievable by holding risky assets alone. No
portfolios can be constructed corresponding to the points in this region. Points
below the frontier are suboptimal. A rational investor will hold a portfolio only
on the frontier.
The risk-free asset
The risk-free asset is the (hypothetical) asset which pays a risk-free rate. It is
usually provided by an investment in short-dated Government securities. The
risk-free asset has zero variance in returns (hence is risk-free); it is also
uncorrelated with any other asset (by definition: since its variance is zero). As a
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result, when it is combined with any other asset, or portfolio of assets, the
change in return and also in risk is linear.
Because both risk and return change linearly as the risk-free asset is introduced
into a portfolio, this combination will plot a straight line in risk-return space. The
line starts at 100% in the risk-free asset and weight of the risky portfolio = 0
(i.e., intercepting the return axis at the risk-free rate) and goes through the
portfolio in question where risk-free asset holding = 0 and portfolio weight = 1.
Portfolio leverage
An investor adds leverage to the portfolio by borrowing the risk-free asset. The
addition of the risk-free asset allows for a position in the region above the
efficient frontier. Thus, by combining a risk-free asset with risky assets, it is
possible to construct portfolios whose risk-return profiles are superior to those
on the efficient frontier.
• An investor holding a portfolio of risky assets, with a holding in cash, has
a positive risk-free weighting (a de-leveraged portfolio). The return and
standard deviation will be lower than the portfolio alone, but since the
efficient frontier is convex, this combination will sit above the efficient
frontier – i.e., offering a higher return for the same risk as the point below
it on the frontier.
• The investor who borrows money to fund his/her purchase of the risky
assets has a negative risk-free weighting – i.e., a leveraged portfolio. Here
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the return is geared to the risky portfolio. This combination will again offer
a return superior to those on the frontier.
The market portfolio
The efficient frontier is a collection of portfolios, each one optimal for a given
amount of risk. A quantity known as the Sharpe ratio represents a measure of
the amount of additional return (above the risk-free rate) a portfolio provides
compared to the risk it carries. The portfolio on the efficient frontier with the
highest Sharpe Ratio is known as the market portfolio, or sometimes the super-
efficient portfolio; it is the tangency-portfolio in the above diagram. This
portfolio has the property that any combination of it and the risk-free asset wil
produce a return that is above the efficient frontier—offering a larger return for
a given amount of risk than a portfolio of risky assets on the frontier would.
Capital market line
When the market portfolio is combined with the risk-free asset, the result is the
Capital Market Line. All points along the CML have superior risk-return profiles
to any portfolio on the efficient frontier. Just the special case of the market
portfolio with zero cash weighting is on the efficient frontier. Additions of cash
or leverage with the risk-free asset in combination with the market portfolio are
on the Capital Market Line. All of these portfolios represent the highest possible
Sharpe ratio. The CML is illustrated above, with return μ p on the y -axis, and riskσ p on the x -axis.
One can prove that the CML is the optimal CAL and that its equation is
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Asset pricing
A rational investor would not invest in an asset which does not improve the risk-
return characteristics of his existing portfolio. Since a rational investor would
hold the market portfolio, the asset in question will be added to the market
portfolio. MPT derives the required return for a correctly priced asset in this
context.
Systematic risk and specific risk
Specific risk is the risk associated with individual assets - within a portfolio
these risks can be reduced through diversification (specific risks "cancel out")
Specific risk is also called diversifiable, unique, unsystematic, or idiosyncratic
risk. Systematic risk (a.k.a. portfolio risk or market risk) refers to the risk
common to all securities - except for selling short as noted below, systematic
risk cannot be diversified away (within one market). Within the market portfolio,
asset specific risk will be diversified away to the extent possible. Systematic risk
is therefore equated with the risk (standard deviation) of the market portfolio.
Since a security will be purchased only if it improves the risk / return
characteristics of the market portfolio, the risk of a security will be the risk it
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adds to the market portfolio. In this context, the volatility of the asset, and its
correlation with the market portfolio, is historically observed and is therefore a
given (there are several approaches to asset pricing that attempt to price
assets by modelling the stochastic properties of the moments of assets' returns
- these are broadly referred to as conditional asset pricing models). The
(maximum) price paid for any particular asset (and hence the return it wilgenerate) should also be determined based on its relationship with the market
portfolio.
Systematic risks within one market can be managed through a strategy of using
both long and short positions within one portfolio, creating a "market neutral"
portfolio.
Diversification
Diversification in finance is a risk management technique, related to hedging
that mixes a wide variety of investments within a portfolio. It is the spreading
out investments to reduce risks. [1]Because the fluctuations of a single security
have less impact on a diverse portfolio, diversification minimizes the risk from
any one investment.
A simple example of diversification is the following: On a particular island the
entire economy consists of two companies: one that sells umbrellas and another
that sells sunscreen. If a portfolio is completely invested in the company that
sells umbrellas, it will have strong performance during the rainy season, but
poor performance when the weather is sunny. The reverse occurs if the portfolio
is only invested in the sunscreen company, the alternative investment: the
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portfolio will be high performance when the sun is out, but will tank when clouds
roll in. To minimize the weather-dependent risk in the example portfolio, the
investment should be split between the companies. With this diversified
portfolio, returns are decent no matter the weather, rather than alternating
between excellent and terrible.
There are three primary strategies used in improving diversification:
1. Spread the portfolio among multiple investment vehicles, such as
stocks, mutual funds, bonds, and cash.
2. Vary the risk in the securities. A portfolio can also be diversified into
different mutual fund investment strategies, including growth fundsbalanced funds, index funds, small cap, and large cap funds. When a
portfolio includes investments with varied risk levels, large losses in one
area are offset by other areas.
3. Vary your securities by industry, or by geography. This wil
minimize the impact of industry- or location-specific risks. The example
portfolio above was diversified by investing in both umbrellas and
sunscreen. Another practical application of this kind of diversification is
mixing investments between domestic and international funds. By
choosing funds in many countries, events within any one country'seconomy have less effect on the overall portfolio.
Diversification reduces the risk of a portfolio, and consequently it can reduce
the returns. However, since diversification reduces the risk of an entire portfolio
being diminished by a single investment's loss, it is referred to as "the only free
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lunch in finance."[2] Statistical analysis shows that there may be some validity to
this claim.[3]
Horizontal diversification
Horizontal diversification is when a portfolio is diversified between same-type
investments. It can be a broad diversification (like investing in several NASDAQ
companies) or more narrowed (investing in several stocks of the same branch
or sector). In the example above, the move to invest in both umbrellas and
sunscreen is an example of horizontal diversification. As usual, the broader the
diversification the lower the risk from any one investment.
Vertical diversification
Vertical diversification is investment between different types of securities
Again, it can be a very broad diversification, like diversifying between bonds
and stocks, or a more narrowed diversification, like diversifying between stocks
of different branches. Continuing the example from the introduction, a vertica
diversification would be taking some money from umbrella and sunscreen stock
and investing it instead in bonds issued the government of the island.
While horizontal diversification lessens the risk of investing entirely in onesecurity, vertical diversification goes beyond that and protects against market
and/or economical changes.
Return expectations while diversifying
The average of all the returns in a diverse portfolio can never exceed that of the
top-performing investment, and will almost always be lower than the highest
return. This is unavoidable, and is the cost of the risk insurance tha
diversification provides. However, strategies exist that allow the portfolio's
manager to maximize returns while still keeping risk as low as possible
Although detailed calculations are beyond the scope of this article, these
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strategies seek to maximize returns by giving
different portfolio weights to investments based on
their risk and return expectations.
Intra-portfolio correlation
Diversification can be quantified by the intra-
portfolio correlation. This is a statistical
measurement between negative one and positive
one that measures the degree to which the various
assets in a portfolio can be expected to perform in a
similar fashion or not. A measure of -1 means that
the assets within the portfolio perform perfectly
oppositely: whenever one asset goes up, the other
goes down. A measure of 0 means that the assets
fluctuate independently, i.e. that the performance of
one asset cannot be used to predict the performance
of the others. A measure of 1, on the other hand,
means that whenever one asset goes up, so do the
others in the portfolio. To eliminate diversifiable risk
completely, one needs an intra-portfolio correlationof -1.
A chart comparing diversification to risk protection
Number of
Stocks in
Portfolio
Average Standard
Deviation of Annual
Portfolio Returns
Ratio of Portfolio Standard
Deviation to Standard
Deviation of a Single Stock
Intra-portfolio
correlation
The linear relationshi
between intra-portfolio
correlation and
diversifiable risk
elimination. Intermediate
values fall on the same
line.
Percent of
diversifia
ble risk
eliminate
d
1 0%
0.5 25%
0 50%-0.5 75%
-1 100%
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1 49.24% 1.00
2 37.36 0.76
4 29.69 0.60
6 26.64 0.54
8 24.98 0.51
10 23.93 0.49
20 21.68 0.44
30 20.87 0.42
40 20.46 0.42
50 20.20 0.41
100 19.69 0.40
200 19.42 0.39
300 19.34 0.39
400 19.29 0.39
500 19.27 0.39
1000 19.21 0.39
Capital market
The capital market is the market for securities, where companies and
governments can raise long-term funds. It is a market in which money is lent for
periods longer than a year. The capital market includes the stock market and
the bond market. Financial regulators, such as the U.S. Securities and Exchange
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Commission (SEC), oversee the capital markets in their designated countries to
ensure that investors are protected against fraud.
The capital markets consist of the primary market and the secondary market
The primary markets are where new stock and bonds issues are sol
(underwriting) to investors. The secondary markets are where existing
securities are sold and bought from one investor or speculator to another
usually on an exchange (e.g. the New York Stock Exchange).
Stock market
A stock market is a public market for the trading of company stock and
derivatives at an agreed price; these are securities listed on a stock exchange
as well as those only traded privately.
The size of the world stock market was estimated at about $36.6 trillion US at
the beginning of October 2008. [1] The total world derivatives market has been
estimated at about $791 trillion face or nominal value, [2] 11 times the size of
the entire world economy. [3] The value of the derivatives market, because it is
stated in terms of notional values, cannot be directly compared to a stock or a
fixed income security, which traditionally refers to an actual value. Moreover
the vast majority of derivatives 'cancel' each other out (i.e., a derivative 'bet' on
an event occurring is offset by a comparable derivative 'bet' on the event not
occurring.). Many such relatively illiquid securities are valued as marked to
model, rather than an actual market price.
.
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Invest ment Philosophy of Reliance Life
Reliance Life Insurance seeks consistent and superior long-term
returns with a well defined and discipline investment approach
symbolizing integrity and transparency to all stakeholders
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Reliance Life offers the different fund options to the
Customers
• ULIP Equity
•
Pure Equity• Infrastructure
• Mid-Cap
• Energy
• Super Growth
• High Growth
• Growth Plus
• Growth
• Balanced
• Corporate Bond
• Pure Debt
• Gilt
• Guaranteed Bond-I
• Money Market
• Capital Secure
The Analyst
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The Portfolio
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The Portfolio
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CONCLUSION
In Portfolio management Investment managers and portfolio structure
is always matter
At the heart of the portfolio management are the managers who invest and
divest client investments.
A certified company investment advisor should conduct an assessment of each
client's individual needs and risk profile. The advisor then recommends
appropriate investments.
Asset allocation
The different asset class definitions are widely debated, but four common
divisions are stocks, bonds, real-estate and commodities. The exercise o
allocating funds among these assets (and among individual securities within
each asset class) is what investment management firms are paid for. Asset
classes exhibit different market dynamics, and different interaction effects
thus, the allocation of monies among asset classes will have a significant effect
on the performance of the fund. Some research suggests that allocation amongasset classes has more predictive power than the choice of individual holdings
in determining portfolio return. Arguably, the skill of a successful investment
manager resides in constructing the asset allocation, and separately the
individual holdings, so as to outperform certain benchmarks (e.g., the peer
group of competing funds, bond and stock indices).
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Long-term returns
It is important to look at the evidence on the long-term returns to different
assets, and to holding period returns (the returns that accrue on average over
different lengths of investment). For example, over very long holding periods
(eg. 10+ years) in most countries, equities have generated higher returns thanbonds, and bonds have generated higher returns than cash. According to
financial theory, this is because equities are riskier (more volatile) than bonds
which are they more risky than cash.
Diversification
Against the background of the asset allocation, fund managers consider the
degree of diversification that makes sense for a given client (given its risk
preferences) and construct a list of planned holdings accordingly. The list wil
indicate what percentage of the fund should be invested in each particular stock
or bond. The theory of portfolio diversification was originated by Markowitz and
effective diversification requires management of the correlation between the
asset returns and the liability returns, issues internal to the portfolio (individua
holdings volatility), and cross-correlations between the returns.
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RECOMMENDATIONS
The Agent should create awareness among the customers about the benefits of
various insurance Plans / Products, and the Investment Philosophy offered by
Reliance life to their customers
1. Agent should go for an extensive personal contact program with the
customers, so that customer may select insurance plans as well as the
Fund Choice per their requirement and available finances for short and
long term investment.
2. Suggestions by Policyholders (through agents)
• Fund switching facility should be finding through easy
process.
• Customer (Policy holder) must aware about the different
fund options and their investment benefits
• If a Policyholder wants to make a fix deposit of matured
policy amount such facility should be available with the
company on primary basis
• A help line desk should be provided in the company’s Office
Premises to give instant attention to Policyholder’s queries/
complaints.
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BIBLIOGRAPHY
www.irdaindia.org
www.reliancelife.com
www.insuranceinstituteofindia.com
www.lifeinsurancecouncil.com
Life Insurance IC-33
Reliance Life Circulars.
Reliance Life Agency Channels Report for the Year 2009-10
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Annexure-I
LIFE INSURANCE CORPORATION ACT, 1956
LIC was established under this Act.
Section 30 of LIC of India Act, 1956.
From the appointed day i.e. 1.9.1956.The Corporation will have the exclusive
privilege of carrying on life insurance business in India.
Certificate granted to any insurer under the Insurance Act, 1938 should cease to
have effect from the said date.
Now, these provisions of section 30 have been altered by incorporation of
Sec30A through IRDA Act, 1999.
As a result, the exclusive privilege given to the corporation to transact life
insurance business has ceased .
The provision of Sec.30A is reproduced hereunder:
“Notwithstanding anything contained in this act, the exclusive privilege of
carrying on life insurance business in India by the corporation shall cease on
and from the commencement of the Insurance Regulatory and Development
Authority Act, 1999 and the corporation shall, thereafter, carry on life
insurance business in India in accordance with the provisions of the
Insurance Act,1938(4 of 1938)’.
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Constitution of LIC
LIC is a body corporate having perpetual existence and common seal.
The corporation shall consist of such number not exceeding sixteen as may be
appointed by the central Government.
One of these members shall be appointed by the Government to be the
Chairman of the Corporation.
The Chairman is the Chief Executive of the Life Insurance Corporation of India.
Actuarial Valuation. [Section 26]
The corporation shall, once at least in every two years, have an investigation to
be conducted by the actuaries into the financial condition of its life insurance
business, including a valuation of its liabilities and submit the report of the
actuaries to the Central Government.[Section 26]
Form 1986, the valuation is done every year.
As required under section 28, 95% of the surplus disclosed by the
actuaries valuation is to be distributed among with-profit policy holders.
The remainder shall be paid to the Central Govt.
Chief Agents and Special Agents [Section 36]
Contracts of chief agents and special agents were terminated by LIC with
effect from 1.9.1956.
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Policies guaranteed by Central Government. [Sec.37]
The sums assured by all policies issued by the corporation including any
bonuses declared in respect thereof, shall be guaranteed as to payment in cash
by the Central Govt.
Section 38.
LIC shall not be placed in liquidation save by Central Government and in such
manner as the Government may direct.
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Annexure-II
INSURANCE REGULATORY & DEVELOPMENT
AUTHORITY ACT, 1999
1. Scope
To permit private companies to enter the insurance market
Government has enacted Insurance Regulatory and Development
Act, 1999
The Act was passed by the Parliament in December 1999
The act provides for the establishment of the authority
1. to protect the interest oh holders of insurance policy;
2. to regulate, p4romote and ensure orderly growth of
insurance industry.
3. for matters connected therewith or incidental thereto.
The Act also sought to amend the following Acts
1. The Insurance Act, 1938
2. The Life Insurance Corporation Act, 1956
3. The General Insurance Business (nationalization) Act, 1972
The Act applies to the whole of India including J&K states.
INSURANCE REGULATORY & DEVELOPMENT AUTHORITY (IRDA)
1. Under this Act, an Authority called “Insurance Regulatory and
Development Authority” (IRDA), has been set up.
2. This is a corporate body established for the purpose and object as set out
in the explanation to the title.
3. The authority replaces “ Controller” under Insurance Act, 1938.
4. The first schedule amends Insurance Act, 1938.
5. It states that if the “Authority” is superseded by central government, the “
Controller “ of insurance may be appointed till such time as the “
Authority” is reconstituted.
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Constitution of IRDA
Insurance Regulatory and Development Authority, consists of thefollowing members
1. a chair person;
2. not more than five whole time members; and
3. not more than four partime members to be appointed by the centra
government.
Members should be persons of ability; integrity; and standing
They should have experience in the field of
1. Life insurance
2. General insurance
3. Actuarial science
4. Finance
5. Economics
6. Law
7. Accountancy
8. Administration
9. Any other discipline thought to be useful by the central government
Chairperson, members, officers and other employees of the authority shal
be public servants.
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Functions:
1. To issue certificate of registration, renew, withdrawal, suspend o
cancel such registration
2. To protect the interest of the policy holders / insured in the manner
of insurance contract with the insurance company
3. To specify requisite qualifications, code of conduct and training for
insurance intermediaries and agents
4. To specify code of conduct for surveyors / loss assessors
5. To promote efficiency in the conduct of insurance business6. To promote and regulate professional organizations connected with
the insurance and reinsurance business
7. To undertake inspection, conduct enquiries and investigations
including audit of insurers and insurance intermediaries.
8. To control and regulate the rates, terms and conditions to be
offered by the insurer regarding general insurance business not so
controlled by Tariff Advisory Committee
9. To specify the form and manner for the maintenance of books of
accounts and the statement of accounts
10. To regulate investment of funds by the insurance companies
11. To adjudicate disputes between insurers and intermediaries o
insurance
12. To supervise the functioning of Tariff Advisory Committee
13. To specify the percentage of life insurance business and Genera
Insurance business to be undertaken in rural or social sector
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Insurance Advisory Committee
1. The Authority can constitute “insurance advisory committee “
through a notification
2. Chairperson of the authority shall be ex-officio
3. Insurance Advisory Committee shall consist of not more than 25
members, excluding ex-officio members to represent the interest of
commerce, industry, transport , agriculture, consumer forum
surveyors, agents, intermediaries, organization engaged in the
safety and loss prevention, research bodies and employees
association in then insurance sectors
4. Members of the authority shall be ex-office members of the
committee
5. The objects of the committee shall be to advice the authority on
matters relating to the making of regulations under section 26, as
also on such matters as maybe prescribed.
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Jitendra
Virahyas