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Established by the Securities and Exchange Board of India

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National Institute of Securities Markets (NISM) Certification Examination for Mutual Fund Distributors.
The announcement made by the Finance Minister in his Budget Speech in February 2005, Securities and Exchange Board of India (SEBI) has established the National Institute of Securities Markets (NISM) in Mumbai. NISM brings out various publications on securities markets with a view to enhance knowledge levels of participants in the securities industry.
All rights reserved. Reproduction of this publication in any form without prior permission of the publishers is strictly prohibited
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BY BETA MONEY MANAGEMENT SERVICES, EDUCATION CELL


betamms.ngp@gmail.com & +91-9579322224

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All agents and distributors should take the MF Advisors module. Computerised multiple choice examination Example:

The NAV of an open-ended fund has to be disclosed Every Friday Every Monday Every Day None of the above

All questions are multiple choice with four options.

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The paper has 70-75 questions, with 1 and 2 mark questions adding up to 100 marks. Candidates have to score a minimum of 50% to pass. A wrong answer will lead to negative marking of 25%. If you get a 2 mark question wrong, you loose 2.5 marks. The marks for each question is given along with the question.

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Each chapter has a weightage: not disclosed. Read the whole book. The question bank has questions stored for each chapter. The question paper for each candidate is different.

The paper is generated by the computer, by randomly choosing from the bank.

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There is a practice exam to help first timers. Detailed instructions are given. Click the blank button of the chosen answer. It will turn black. Clicking another answer for the same question will automatically change the answer to the new one. Clicking on the black button of the chosen answer, will make it blank. You can scroll up and down and change your answers.

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There are 90 minutes to do the paper. There is a clock on the screen. At the end of the 90 mins, paper will be automatically submitted. There is a back-up sheet on which answers can be written. Once you click on finish, a summary of attempted and unattempted questions appears. You can go back to the paper. If you saysubmit at this stage, your marks will be displayed. Exam over

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Todays AMFI Training Program - The Agenda


Session 1
Session 2 Session 3 Session 4

Concept & Product


Regulatory Framework The Investment Process Investor Services

Session 5
Session 6 Session 7 Session 8

Markets & Portfolio Management


Accounting & Valuation Risk, Return & Performance Financial Planning

Session 9

Business Ethics

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Session 1
Mutual Funds - Concept & Product

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Contents - Session 1
Introduction Mutual fund products Sponsor-Trustee-AMC Other constituents Regulatory framework Merger and acquisitions

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A mutual fund is a pool of money collected from investors and is invested according to stated investment objectives.

Terms to know

Mutual Pool Investment objectives

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Investors own the mutual fund. Professional managers manage the affairs for a fee. The funds are invested in a portfolio of marketable

securities, reflecting the investment objective.

Value of the portfolio and investors holdings, alters with change in market value of investments.

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Advantages of Mutual Funds


Portfolio diversification Professional management Reduction in risk Reduction in transaction cost Liquidity Convenience and flexibility No control over costs No tailor-made portfolios Issues relating to management of a portfolio of mutual funds

Disadvantages of Mutual Funds


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Open

ended funds

Initial issue for a limited period Continuous sale and repurchase Size of the fund changes as investors enter and exit NAV-based pricing

Closed

ended funds

Sale of units by fund only during IPO Listing on exchange and liquidity for investors Size of fund is kept constant Price in the market is usually at a discount

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Pre-dominantly

invest in equity markets

Diversified portfolio of equity shares Select set based on some criterion

Diversified

equity funds

ELSS as a special case

Primary

market funds Small stock funds Index funds Sectoral funds

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Predominantly

invest in the debt markets

Diversified debt funds Select set based on some criterion

Income

funds or diversified debt funds Gilt funds Liquid and money market funds Serial plans or fixed term plans

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Investment

in more than one asset class

Debt and equity in comparable proportions Pre-dominantly debt with some exposure to equity Pre-dominantly equity with some exposure to debt

Education

plans and childrens plans

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Investors

can achieve income and growth objectives in all funds


Dividend option

Regular dividend Ad-hoc dividend

Growth option Re-investment option

Most

funds provide multiple options and the facility to switch between options

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Risk

Sectoral funds are most risky; money market funds are least risky
Equity funds require a long investment horizon; liquid funds are for the short term liquidity needs

Tenor

Investment

objective

Equity funds suit growth objectives; debt funds suit income objectives

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Sectoral funds Equity funds Index funds Balanced funds Debt Funds Gilt funds ST debt funds

Liquid funds
Risk
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Session 2
Mutual Funds - Regulatory Framework

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3-tier structure

Sponsor Trustee AMC

The regulatory Framework UTI - The lessons learnt Self regulatory Organisations Mergers & Acquisitions

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Promoter of the the mutual fund Creates AMC and appoints trustees Criteria

Financial services business 5-year track record 3-year profit making record At least 40% contribution to AMC capital

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Fiduciary responsibility for investor funds Appointed by sponsor with SEBI approval Registered ownership of investments is with Trust Board of trustees or Trustee Company Appoints all other constituents At least 4 trustees

2/3 should be independent

Trustees of one mutual fund cannot be trustee of another mutual fund Right to seek regular information and remedial action All major decisions need trustee approval

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Responsible for operational aspects of the MF Investment management agreement with trustees Registered with SEBI Rs. 10 crore of net worth to be maintained at all times At least 1/2 of the board members to be independent Appoints other constituents Cannot have any other business interest Structured as a private limited company

Sponsor and associates hold capital

AMC of one MF cannot be trustee of another MF Quarterly reporting to Trustees

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Custodian

Investment back-office
Investor records and transactions

Registrar and Transfer agent

Broker

Purchase and sale of securities 5% limit per broker


Separate auditor for AMC and mutual fund

Auditor

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SEBI (Mutual Fund) Regulations, 1996 RBI as regulator

Guarantees of sponsors in bank-sponsored mutual funds Regulator of G-Secs and money markets

Stock exchanges (for listed Mutual Funds) Companies Act

AMCs and Trustee Company RoC for Compliance CLB for prosecution and penalties Registration Complaints against trustees

Office of the public trustee

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Formed as a trust under UTI Act, 1963 Voluntary submission to SEBI regulation No separate sponsor or AMC Major Differences

Assured return schemes Different accounting norms Ability to take and make loans

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Derive powers from regulator


Ability to make bye-laws Example : Stock exchanges Industry Associations

Collective industry opinion


Guidelines and recommendation Example: Association of Mutual Funds in India

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Scheme takeover

AMC merger

One AMC buys schemes of another AMC Organic growth in assets No change in AMC stakes Two AMCs merge Similar to merger of companies Sponsor stakes change Stake of one sponsor in a AMC bought out by another sponsor Change in AMC and sponsor No prior approval needed Option to exit at NAV Right to be informed

AMC take-over

Investor rights

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Session 3
Mutual Funds - The Investment Process

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Scheme Information Document Key Information Memorandum Application and form of holding Distribution channels Investors rights Taxation of Income and capital gain NAV and Load

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Scheme Information Document


Legal offer from AMC to investor

Contains vital information about Fund and schemes


SEBI approved format KIM is a mandatorily enclosed to application forms Investor has no recourse for not having read the OD/KIM

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Updated every 2 years for OEFs Regular Addendum for results Updated for every major change
Change in the AMC or Sponsor of the mutual fund. Change in the load structures. Changes in the fundamental attributes of the schemes. Changes in the investment options to investors; inclusion or deletion of options.

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Scheme type

Investment objective
Investment pattern Terms of the scheme with regard to liquidity

Fees and expenses


Valuation norms and accounting policies Investment restrictions

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Investors have right to be informed Public announcement by AMC Option to exit without load SEBI and Trustee approval

New offer document

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Preliminary information

Summary information about the mutual fund, the scheme and the terms of offer. Mandatory disclaimer clauses as required by SEBI. Glossary of terms in the offer document, which defines the terms used. Standard and scheme specific risk factors pertaining to the scheme being offered Constitution of fund, details of sponsor, trustees and AMC. Financial history of sponsor(s) for 3 years, in summary form. Director of Boards of the trustees and the AMC. Details of key personnel of the AMC. Details of Fund constituents

Fund specific information


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Scheme Specific Information

Details regarding IPO, sale and Repurchase Minimum subscription and face value Initial issue expenses current scheme and the past schemes Special facilities to investors Eligibility for investing documentation required. Procedure for applying, and subsequent operations relating to transfer, redemption, nomination, pledge and mode of holding Proposed as well as other schemes for last 3 years Comparison with OD numbers Condensed Financial information for last 3 years

Loads and the annual recurring expenses


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Rights of unit holders

services & information protection of rights and problem resolution.

Details of information disclosure and their periodicity. Documents available for inspection Details of pending litigation and penalties Cannot sue the mutual fund 75% unit holders can

wind up a scheme seek AMC termination

Prospective investor has no rights Right to redeem for fundamental changes

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Summary information on associate companies being used as constituents.


Summary information of associates investing in schemes of the mutual fund.

Summary information on investment made by mutual fund schemes in associate company securities.

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SEBI: Format and Content Trustee Approval Compliance Office certifies that

information contained therein is true and fair is in accordance with SEBI regulations constituents of the fund are all SEBI registered entities

The AMC is responsible for the contents and the accuracy of information

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Units or amount Certificates and account statement Minimum amount Initial offer and subsequent buying List of eligible investors

Check eligibility with offer document Foreign investors not eligible (FII Regulations)

Documents for classes of investors

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Individual agents Distribution companies


NBFCs and Broking Houses Service and Collection Advisory

Banks
Private / HNI Banking Branch Banking Corporate Banking Special Investment Advisory Desks

Direct marketing channels

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Proof

of purchase

Certificate Account statement


Application

Joint holding Minor Nomination PAN number Tax status Folio number Bank details

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Sale and repurchase price are NAV-based

Cut-off time for NAV


Entry load is charged on NAV and increases the sale price Exit load is charged on NAV and reduces the repurchase price

Load is a charge on the NAV


Load is defined as a percentage CDSC is variable exit load, charged depending on duration of stay in the fund Loads are subject to SEBI Regulation and vary depending on industry practice

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If the entry load (sales load) for a scheme is 1.5% and the NAV of the scheme is Rs. 10.00, the investor who wants to buy the units will not be able to buy at Rs. 10.00. He will pay: = 10.00 + (10.00*1.5/100) = 10.00 + 0.15 = 10.15

Exit Load : Example


If a fund imposes an exit load of 1.25%, the investor who repurchases his units, will get a price that is: = 10.00 (10.00*1.25/100)=10.00-0.125 = 9.875

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There are 2 regulatory requirements:

The sale price cannot be more than 107% of the NAV and the repurchase price cannot be less than 93% of the NAV. That is, the maximum load can be only 7%. The repurchase price cannot be less than 93% of the sale price.
For a close ended fund, the limits are set at 5% of NAV

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If the NAV is Rs. 10,


Sale

price cannot be higher than Rs. 10.7. Repurchase price cannot be lower than Rs. 9.3. However, the mutual fund cannot charge both these prices. If the sale price is Rs. 10.7, the repurchase price cannot be lower than Rs. 9.95 (10.7*0.93). If the repurchase price is Rs. 9.3, the sale price cannot be higher than Rs.10 (9.3/0.93).

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Mutual fund is exempt from paying taxes (Section 10 (23D)) Income for investors

Dividend Capital gain Dividend exempt from tax Fund pays dividend distribution tax at 12.5% Open end funds with >65% in equity, fully exempt. Tax arbitrage for investors

Present position (AMFI examination)


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Long term: > 12 months, Short term: < 12 months Long term capital gains subject to indexation benefit

20% +surcharge after indexation 10% + surcharge without indexation

Short term capital gains taxed at marginal rate of taxation.

Indexation - An Example
Investor buys on March 31, 1999 and sells on April 1, 2000. What is the indexation adjustment factor? (1998-99 - 351, 1999-2000 - 386, 2000-01 - 406) Investor buys on April 1, 1998 and sells on March 31, 2001. What is the indexation adjustment factor?

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Session 4
Investor Services

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Importance of Services for Investors Source of Information on Fund Services Applying for and Redeeming MF Units Investment Plans/ Options and Services

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While choosing the right fund to invest, an investor and his advisor need to consider the following factors:

The most important factor is the package of overall services provided by the the fund Convenience is an important advantage of a mutual fund Selected fund should be examined to see if they offer the investor the desired level of service

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Most comprehensive source is the Scheme Information Document of the scheme in question The Scheme Information Document details the procedure for purchase and redemption of units and specifies other investor services

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Who can Apply

Indian citizens, Indian entities, NRIs and foreign entities

Procedure for Purchase of Units: Appointing Registrars, Investor Service Centres to carry out the following:

Ensuring the completion and collection of the required application form Acceptable mode of payment Permissible places of payment Minimum subscription required

Procedure for Redemption of Units : Details are contained in the Scheme Information Document
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Automatic Reinvestment Plan (ARP) : Allows the investor to reinvest amount of dividends or other distributions made back into the same fund and receive additional units Systematic Investment Plan (SIP) : These require the investor to invest a fixed sum periodically Systematic Withdrawal Plan (SWP) : Allows the investor to make periodic withdrawals from his funds

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Session 5
Markets & Portfolio Management

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What

is Investment/ Portfolio Management? Equity Portfolio Management Debt Portfolio Management Investment restrictions

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Investment or Portfolio Management is a specialist function. After collecting and investing an investors money effective portfolio management will have to give acceptable returns to the investor, in order to keep him satisfied and prevent him from moving to any other competitor fund

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An equity portfolio managers task consists of two major steps :

Constructing a portfolio of equity shares or equitylinked instruments consistent with the investment objective Managing or constantly rebalancing the portfolio

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Types of Equity Instruments


Ordinary Shares Preference Shares Equity Warrants Convertible Debentures Equity Classes

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Market Capitalisation
Market Capitalisation is equivalent to the current value of a company. There are Large Capitalisation companies, Mid-Cap companies and Small-Cap companies

Classification in Terms of Anticipated Earnings


Price Earning Ratio Cyclical Stocks Growth Stocks Value Stocks

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Investment Strategies:

Growth and value Active and passive Large and small cap Cyclical stock Stock selection
P/E ratio Dividend yield Undervalued companies

Fundamental analysis Technical analysis Quantitative analysis

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Portfolio Management Organization Structure


Three types of skilled employees :

Fund Managers, each assigned to a specific scheme or set of schemes

Security Analysts and Researchers


Security Dealers

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Use of Equity derivatives


In India, SEBI permitted the use of futures and options by mutual funds only for two purposes :

Risk Management Portfolio Balancing

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Tenor

short and long put and call options Fixed and floating Periodic v/s Discounted Gilt, guaranteed, and others

Interest payment

Credit quality

Traded and non-traded

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Increase in rates reduces value of existing bonds. Decrease in rates increases value of existing bonds Price and yield are inversely related The relationship between yield and tenor can be plotted as the yield curve.

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Current Yield and YTM


Coupon as a percentage of current market price If we bought a 8% bond at Rs. 110, the current yield = (8/110)*100 = 7.27%

Rate at which present value of future cash flows equals the current market price. Given price, YTM can be calculated through iteration. Given YTM, price can be computed, using the YTM rate to discount the future cash flows

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Measured by a number called duration. If duration is 3 years, and interest changes by 1%, price of the bond will change in the opposite direction, by 3%.

Example
Example: Duration of a bond is 4 years. Yield spreads increases by 1.5%. what is the change in price? Change in the Price = 1.5 *4 = -6%

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Probability of default by the borrower Change in credit rating:

downgrade increases the yield and decreases the price upgrade decreases the yield and increases the price

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Buy and hold

Portfolio exposed to interest rate risk. increase duration if rates are expected to fall decrease duration if rates are expected to rise invest in low grade bonds that are likely to be upgraded.

Duration management

Credit selection

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Invest only in marketable securities.

Investment only on delivery basis


A mutual fund under all its schemes, cannot hold more than 10% of the paid-up capital of a company Not more than 10% of its NAV in a single company

Exceptions: Index Funds and Sectoral funds

Rated investment grade issues of a single issuer cannot exceed 15% of the net assets

Can be extended to 20%, with the approval of the trustees

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Investment in unrated securities of one company cannot exceed 10% of the net assets of a scheme and not more than 25% of net assets of a scheme can be in such securities Investment in unlisted shares cannot exceed
5% of net assets for an open-ended scheme, 10% of net assets for a close-ended scheme

Mutual funds can invest in ADRs/GDRs


up to a maximum limit of 10% of net assets or $50 million, whichever is lower. The limit for the mutual fund industry as a whole is $500 million

Mutual funds can also invest in a limited manner in treasury bonds and AAA rated corporate debt issued outside India.

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Such transfers happen on a delivery basis, at market prices. Such transfers should not result in significantly altering the investment objectives of the schemes involved. Such transfer should not be of illiquid securities, as defined in the valuation norms. One scheme can invest in another scheme, up to 5% of net assets. No fee is payable on these investments.

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A mutual fund scheme cannot invest in unlisted securities of the sponsor or an associate or group company of the sponsor. A mutual fund scheme cannot invest in privately placed securities of the sponsor or its associates. Investment by a scheme in listed securities of the sponsor or associate companies cannot exceed 25% of the net assets of the scheme

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Mutual funds cannot make loans Mutual funds can borrow upto 20% of net assets for a period not exceeding 6 months. Derivatives can be used only after informing investors Any change in investment objectives requires information to investor, and provision of option to exit at NAV, without exit load.

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Session 7
Mutual Funds - Accounting & Valuation

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Net assets Accounting policy Initial issue expenses Operating expenses: Limits AMC fees Disclosure and reporting norms Valuation norms

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+
+ +

Market value of investments


Current assets and other assets Accrued income

Current liabilities and other liabilities


Accrued expenses NAV = Net assets/Number of units

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Sale and purchase of securities

Cannot impact NAV by more than 2% Cannot impact NAV by more than 2%

Sale and repurchase of units

Valuation of assets Accrual of income and expenses

Cannot impact NAV by more than 1%

Frequency of NAV Calculation


Everyday by 8.00 p.m on AMFI website Open ended funds: Daily, Close ended funds: Weekly Exempt funds: CEFs which are not listed (UTIs Monthly income schemes)

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Business day definition and applicable NAV are stated in the offer document Cut off time for each scheme is also announced. Prospective NAV applies to applications made before the cutoff time.

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Investments to be marked to market according to SEBI Guidelines. Unrealised appreciation cannot be distributed. Profit or loss on average cost basis. Dividend on ex-dividend date. Sale and purchase accounted on trade date. Brokerage and stamp duties are capitalised and added to cost of acquisition or sale proceeds

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Interest Dividend Profit from sale of investments Other income Extra-ordinary income

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Expenses incurred in floating schemes

Limit of 6%; excess expenses to be borne by AMC/sponsor


CEF : Amortise on weekly basis until maturity OEF : Amortise over period not exceeding 5 years No-load fund: additional fees

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Investment management fees Custodians fees Trustee Fees Registrar and transfer agent fees Marketing and distribution expenses Operating expenses Audit fees Legal expenses Costs of mandatory advertisements and communications to investors

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For net assets up to Rs. 100 crore: 2.5%

For the next Rs. 300 crore of net assets: 2.25%


For the next Rs. 300 crore of net assets: 2% For the remaining net assets: 1.75% Applied on the weekly average net assets of the mutual fund scheme. On debt funds the limits on expenses are lower by 0.25%.

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Penalties and fines for infraction of laws. Interest on delayed payments to unit holders. Legal, marketing and publication expenses not attributable to any scheme. Expenses on investment and general management. Expenses on general administration, corporate advertising and infrastructure costs. Expenses on fixed assets and software development expenses. Such other costs as may be prohibited by SEBI.

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For the first Rs. 100 crore of net assets: 1.25% For net assets exceeding Rs. 100 crore: 1.00% 1% higher fee for no load funds Balance of DRE not included in net assets for computing investment management fee and expense limits.

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Audited accounts within 6 months of closure of accounts. Publish within 30 days of the closure of the half-year, unaudited abridged accounts. Summary of the accounts has to be mailed to all unit holders. File with SEBI:

A copy of the annual report Six monthly unaudited reports Quarterly movement in net assets of the Quarterly portfolio statements

fund

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Complete portfolio to be disclosed every six months.

Industry practice: monthly disclosure.

Any item of expenditure which is more than 10% of total expenses NPAs, provisioning, NPAs as % of total assets. Number of unit holders holding more than 25% of unit capital.

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An asset shall be classified as an NPA, if the interest and/or principal amount have not been received or have remained outstanding for one quarter, from the day such income/installment has fallen due. Such assets will be classified as NPAs, soon after the lapse of a quarter from the date on which payments were due.

Treatment of NPAs
Accrual to be stopped. Income accrued until date of classification to be provided for. Provisioning for principal due In graded manner after 3 months of classification. Complete write off in 15 months from classification

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93

Market price for all frequently traded securities Illiquid and thinly traded equity

Valuation procedure

Debt:
< 182 days accrual principal. > 182 days common valuation methodology

Illiquid securities to not exceed 15% of net assets.

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Market price for Liquid shares

Price should not be more than 30 days old Earnings based SEBI approved model Less than Rs. 5 lakh value and Less than 50,000 shares

Fair valuation for Illiquid shares

Fair Valuation for Thinly traded shares

Valuation: Debt
YTM based for Gilt and Corporate securities with investment grade rating 25% discount for speculative grade performing assets NPA norms for NPAs Accrual for money market securities

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95

Last traded price in the exchange where the security is principally traded. Previous traded date as long as such date is not over 30 days ago.

Thinly Traded Securities


Equity shares

Traded value in a month is less than Rs. 5 lakhs; and Total volume of shares traded is less than 50,000 shares a month
Debt security

Traded value of less than Rs. 15 crore in the 30 days prior to the valuation date.

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Book value of the share Earnings capitalisation value

Discount the industry P/E by 75% 10% discount for illiquidity EPS if negative Accounts not available for 9 months after closing date.

Average of the two methods

Earning capitalisation is zero if


If illiquid securities are more than 5% of the portfolio, independent valuation to be done

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For example, if a security was issued at Rs. 90 and redeemable at Rs. 100, after 364 days, the accrued interest for each day is = 10/364 = 0.02747 The value of the security is increased by 2.747 paise every day, so that the security is worth Rs. 100 on the date of maturity. If it has to be valued 200 days after issuance, its value is 90+(0.02747*200) = 95.494
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G-Secs are valued at market prices or using the CRISIL Gilt valuer.
Corporate bonds are valued at market prices or using the CRISIL Bond valuer. Both these methods use duration to classify bonds and assign a rate for each duration bucket.

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99

Session 8
Risk, Return and Performance

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100

Return Methods

Change in NAV Total Return Total Return with dividend re-investment CAGR Standard deviation Beta and Ex-Marks

Risk

Benchmark and comparison

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Sources of return

Dividend Change in NAV

Return = Income earned for amount invested over a given period of time Standardise as % per annum Computing return

Percentage

change in NAV. Simple total return ROI or Total return with dividend re-investment Compounded rate of growth

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Assume that change in NAV is the only source of return. Example:

NAV of a fund was Rs. 23.45 at the beginning of a year Rs. 27.65 at the end of the year.

%age change in NAV = (27.65 23.45)/23.45 *100 = 17.91%

Annualizing the Rate of Return


If NAV on Jan 1, 2001 was Rs. 12.75 and the NAV on June 30, 2001 was Rs. 14.35,

% age change in NAV = (14.35 12.75)/12.75 x 100 = 12.55% Annualised return = 12.55 x 12/6 = 25.10%

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Investor bought units of a mutual fund scheme at a price of Rs.12.45 per unit. He redeems the investment a year later, at Rs. 15.475 per unit. During the year, he also receives dividend at 70%. The rate of return on his investment can be computed as =((15.475 12.45) + 0.70)/12.45 x 100 = (3.725/12.45) x 100 = 29.92%

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104

(Value of holdings at the end of the period - value of holdings at the beginning of the period)/ value of holdings at the beginning of the period x 100 Value of holdings at the beginning of the period = number of units at the beginning x begin NAV.

Value of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAV.
Number of units re-invested = dividends/ex dividend NAV.

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105

An investor buys 100 units of a fund at Rs. 10.5 on January 1, 2001. On June 30, 2001 he receives dividends at the rate of 10%. The exdividend NAV was Rs. 10.25. On December 31, 2001, the funds NAV was Rs. 12.25. What is the total return on investment with dividends re-invested?

ROI Method: Solution


The begin period value of the investment =10.5x100= Rs. 1050 Number of units reinvested = 100/10.25 = 9.756 units End period value of investment = 109.756 x 12.25 = Rs. 1344.51 The ROI =(1344.51-1050)/1050 x 100 = 28.05%
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CAGR is the rate at which investment has grown from begin point to the end point, on an annual compounding basis.
V0(1+r)n = V1 r =((V1/V0)1/n)-1 Where n is the holding period in years.

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107

An investor buys 100 units of a fund at Rs. 10.5 on January 6, 2001. On June 30, 2001 he receives dividends at the rate of 10%. The exdividend NAV was Rs. 10.25. On March 12, 2002, the funds NAV was Rs. 12.25. Compute the CAGR.

CAGR: Solution
The initial value of the investment= 10.5 x 100 = Rs. 1050 Number of units reinvested = 100/10.25 = 9.756 units Final value of investment = 109.756 x 12.25 = Rs. 1344.51 Holding period = 6/01/01 - 12/3/02 = 431 days The CAGR is =(1344.51/1050)365/431 - 1 x 100 = 23.29%

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108

Growth Option: CAGR implicit in the change in holding period NAVs. Dividend Option: CAGR implicit in the change in value over the holding period, assuming reinvestment of dividend at exdividend NAV. Less then 1 year, simple return without compounding or annualisation. Some funds use simple annualised return, without compounding.

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109

Standard measurements and computation Compounded annual growth rate for funds over 1 year old. Return for 1,3 and 5 years, or since inception, which ever is later.

No annualisation for periods less than a year.

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110

Risk arises when actual returns are different from expected returns. Historical average is a good proxy for expected return. Standard deviation is an important measure of total risk. Beta co-efficient is a measure of market risk. Ex-marks is an indication of extent of correlation with market index.

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111

Relative returns are important than absolute returns for mutual funds. Comparable passive portfolio is used as benchmark. Usually a market index is used. Compare both risk and return, over the same period for the fund and the benchmark. Risk-adjusted return, is the return per unit of risk.

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112

Benchmark should reflect the asset allocation Same as stated in the offer document Growth fund with more than 60% in equity to use a broad based index. Bond fund with more than 60% in bonds to use a bond market index. Balanced funds to use tailor-made index Liquid funds to use money market instruments.

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113

Tracking error Tracking error for index funds should be nil. Credit quality Rating profile of portfolio should be studied Expense ratio Higher expense ratios hurt long term investors Portfolio turnover Higher for short term funds and lower for long term funds Size and portfolio composition

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114

Session 9
Mutual Funds & Financial Planning

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115

Concept of financial planning Mapping life cycles and wealth cycles Financial products Asset allocation Model portfolios Fund selection

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116

Financial planning identifies all the financial needs of an investor and translates the needs into monetarily measurable goals. These goals can be short term, medium term and long term. A Financial Planner plans the financial investments that will allow these goals to be met.
Financial Planning provides direction and meaning to financial decisions. It helps to understand how each financial decision effects other areas of ones finances By viewing each financial decision as part of a whole one can consider its short and long term effects on ones life goals

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117

Forms the core foundation and building block for any type of FP Variety of products available to suit any need or combination of needs Barring life and property insurance, rest of the product portfolio can be created out of bouquet of MFs

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118

Understands: The universe of investment products Risk-return attributes Tax and estate Planning Has the ability to convert life cycles of investors into need and preference based financial products Organised approach to work Excellent communication and interpersonal skills

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119

Wealth

cycle based classification Life cycle based classification

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120

Step I: Establish and define the relationship with the client Step II: Define the clients goals Step III: Analyse and evaluate clients financial status Step IV: Determine and shape the clients risk tolerance level Step V: Ascertain clients tax situation Step VI: Recommend the appropriate asset allocation and specific investments Step VII: Executing the plan Step VIII: Periodic Review

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121

Physical Assets Gold & Real Estate Bank Deposits Corporate Shares, Bonds, Debentures & Fixed Deposits Government G. Secs, PPF, RBI Relief Bonds and other personal Investments Financial Institutions Bonds, Shares Insurance Companies Insurance Policies

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122

Available since a long period of time Large geographical network transactions made easy & convenient Fund transfer mechanism available Perception of bank deposits being free of default; Deposits guaranteed up to Rs 1 lakh per depositor Electronic facilities make it liquid and easy to use

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123

15 years deposit product made available through banks.

9% p.a. interest payable on monthly balances


Minimum Rs. 100 & maximum Rs. 70,000 p.a investment allowed. Tax benefits u/s 88 under IT Act. Limited by taxable income slabs. Interest receipt and withdrawal of principal exempt from tax. Limited liquidity available.

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124

Issued by banks on behalf of the RBI Tenure of five years 6.5% p.a. interest payable s.a. Proposed to be converted to floating rate instrument linked to government yields Option to receive or reinvest interest Interest income exempt from tax Limit of Rs.2 lakh per annum, except for severance benefits.

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125

IVP & KVP issued by central government & sold by post offices Interest is taxable Investor identity is protected and investment in cash is possible Post office savings and RD gives fixed rate of interest but are not liquid. These are government guaranteed deposits Attractive for their safety and cash investment options

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126

Commercial Paper Debentures Equity Shares Preference Shares Fixed Deposits Bonds of FI

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127

Compare options by nature of investments Characteristics, benefits and risks. Current performance and suitability Taxability, age, risk profile.

Why MF is the Best Option?


Mutual funds combine the advantages of each of the investment products Dispense the short comings of the other options Returns get adjusted for the market movements

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128

Harness the power of compounding Start early Have realistic expectations Invest regularly

Useful Strategies
Rupee Cost Averaging Value Averaging Jacobs rebalancing strategy Grahams 50:50 rebalancing strategy

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129

Invest regularly a predetermined amount Invests in more units when the market is low; less when the markets are high. Reduces the average cost of purchase

Value Averaging

Invest regularly to achieve a predetermined value Book profits at a high, and adds units at the low, and enables meeting financial goals. Reduces the average cost of purchase

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Amount NAV per Number of Cumulative Invested unit units bought number of (Rs) units 1000 12.5 80.00 80.00 1000 11.25 88.89 168.89 1000 10.75 93.02 261.91 1000 11 90.91 352.82 1000 12.75 78.43 431.25 1000 13.35 74.91 506.16 1000 13.85 72.20 578.36 1000 14.45 69.20 647.57 1000 13.85 72.20 719.77 1000 13.5 74.07 793.84 Average cost 12.60

Value of holding 1000.00 1900.00 2815.56 3881.03 5498.47 6757.22 8010.30 9357.32 9968.78 10716.86

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Target NAV Per Value Of Value Unit Holding 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 12.5 11.25 10.75 11 12.75 13.35 13.85 14.45 13.85 13.5

Units Cumulative To Balance Invest 0.00 80 80 900.00 97.78 177.78 1911.11 101.29 279.07 3069.77 84.57 363.64 4636.36 28.52 392.16 5235.29 57.28 449.44 6224.72 55.98 505.42 7303.25 48.22 553.63 7667.82 96.19 649.82 8772.56 90.92 740.74
132

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Deciding the allocation of funds amongst equity, debt and money market. Incorporating product, investor profile and preferences in the portfolio Equity, debt and money market products are called asset classes. Allocating resources to each of these is called asset allocation.

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133

Based on the 50:50 rule. Basic managed portfolio. Basic indexed portfolio. Simple managed portfolio. Complex managed portfolio. Readymade portfolio.

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134

Combine age, risk profile and preferences in asset allocation

Older investors in distribution phase 50% equity;50% debt Younger investors in distribution phase 60% equity; 40% debt Older investors in accumulation phase 70% equity; 30% debt Younger investors in accumulation phase 80% equity; 20% debt

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135

Fixed ratio between asset classes

Portfolio has to be periodically re-balanced Disciplined approach Enables investor to book profits in a rising market and invest more in a falling market
No re-balancing; asset class proportions can vary when prices change. If equity returns are higher than debt returns, equity allocation will go up at a faster rate

Flexible allocation

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136

Develop long term goals

Investment avenues, time horizon, return and risk


Allocation to broad asset classes Allocation of sectors of the mutual fund industry Compare products and choose actual funds to invest in

Determine asset allocation

Determine sector distribution

Select specific fund schemes for investment

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137

Accumulation phase

Diversified equity: 65 - 80% Income and gilt funds: 15 - 30% Liquid funds: 5% Diversified equity: 15 - 30% Income and gilt funds: 65 - 80% Liquid funds: 5%

Distribution phase

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138

Equity funds: Characteristics

Fund category Suitability to investor objective Investment style Growth vs Value Age of the fund Experience preferred to new fund Fund management experience Size of the fund Larger funds have lower costs Performance and risk

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Percentage holding in cash. Concentration in portfolio. Market capitalisation of the fund. Portfolio turnover. Risk Statistics

Beta Ex-Marks Gross dividend yield Funds with low beta, high ex-marks and high gross dividend yield is preferable

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140

A smaller or new debt fund may not necessarily be risky Total return rather than YTM is important Expense very important

High expense ratios lead to yield sacrifice

Credit quality

Better the rating of the holdings, safer the fund


Higher average maturity means higher duration and interest rate risk

Average maturity

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Liquidity and high turnover rate

Shorter term instruments are turned over more frequently. NAV fluctuation limited due to low duration and low levels of interest rate risk.

Protection of principal invested

Credit quality of portfolio Low expense ratio

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142

Session 9
Business Ethics for Mutual Funds

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What is meant by Business Ethics ? Need for Business Ethics Objectives Key Terms Fund Regulators and Business Ethics

Responsibilities Objectives Requirements Operations Publicity

Ethical Issues and Responsible Investing


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It means rules of acceptable and good conduct Rules may be set my those who own and run a business or by an agency

Need for Business Ethics


In a civilised society business must be conducted in an ethical, disciplined, organized and fair manner. Good ethics is good business. Ethical practices ensure that the customer remains a long term and satisfied buyer Honesty is the Best Policy

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145

Simply be honest, open and transparent with all your current and potential clients
Protect customers from being cheated and exploited Ensure a level field playing among all categories of business participants

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146

Fair Business Practices Ethical Standards Ethical norms or guidelines A Code of Conduct Ethical Business Practices Conflict of interest in a mutual fund business

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Responsibilities

Primarily concerned with the protection of investors


Develop code of conduct for fund distributors, fund managers, all employees and associated persons of AMCs May lay down its own rules of ethics Investigates any practices that run counter to the interest of fund investor

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Objectives

Fund Structure and Governance


Exercise of Voting Rights by Funds Fund Operations

Requirements

Separation of Functions

Independence of Organisations
Independence of Personnel

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Fund Operations
Insider Trading Preferential treatment to selected investors Personal training by fund managers and employees

Fund Publicity
Publicity and advertisements provide the investors correct, complete and relevant information needed to make the investments in mutual funds

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Fully protect the best interests of the investor Prudent Investing which refers to the quality and safety of investments Responsible Investing means that fund managers must invest with a sense of responsibility

Screening Investments Shareholder Activism by fund advisors/ managers Community Investing

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151

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152

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