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111. '' If these fund become sucessful, then it would be a cakewalk for the MF companies to mobilize the funds .'' How are derivative instruments used for managing risk in Mutual Funds?
The growth of MF will be consistent in the near future as MF investment is still a favorite option for the retail investors . In an attempt to protect the banking industry and impede the stream of investments to MFs, Union Finance Minister P Chidambaram , in his Union Budget 2006-07 speech, announced the benefit of Section 80C to bank deposits above five years . It can be the primary or the only option available for the investors if the bank rates remain same or go down further and floating rates are introduced on bank deposits paving way for volatility in bank returns . If the RBI adopts floating rates interests on bank deposits, the investor will not have any reservation for bank deposits as he cannot differentiate between the bank deposit and MF in term of volatility in returns , which enables the MF industry to grow rapidly and continue to attract new investors . In additions to this , SEBI took steps to bring in derivative instruments in to the Mutual Fund Industry . The introduction of Derivative Funds made MFs look less risky and close to assured or guaranteed returns. If these Funds become sucessful, then it would be a cakewalk for the MF companies to mobilize the funds.
Ans: There is growing recognition on the use of derivative instruments in managing Mutual Fund risk. These instruments can either be options , futures , forwards and / or swaps. Debt portfolio is exposed to interest rate risk while equity portfolio is exposed mainly to price risk. In India , Interest rate futures , option contracts and interest rate swaps are available for hedging interest rate risk. Derivative instrument like futures is used to modify systematics risk of the portfolio ; if the Fund Manager expects the market to rise , he can increase the portfolio beta by using put option and when the Fund Manager expects the market to rise , he can increase the portfolio beta by using put option and when the Fund Manager expects a fall in the market he can decrease the portfolio beta . Futher , Fund Manager can use various options and futures instruments to reduce the unsystematic risk or market risk. For example , the Fund Manager can buy a call option when he anticipates a risisng market in sector or Industry or in a group of individual stock.