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Arbitrage Funds - An alternative to Debt Funds?

Thread: Arbitrage funds as the name suggests tries to locate the mispricing in cash market and derivatives market of any security to generate returns for investors.
How?
Suppose Infosys is trading at Rs. 600 in cash segment and at Rs. 605 in Futures segment for current month expiry, The fund manager will go short on future and will buy equal amount of INFY stock in cash market.
This will create a fully hedged position in the stock.
The future trades at premium because of time value in the contract. Now as the expiry day comes closer, the premium on futures will keep on reducing and on the expiry day, prices in both the markets will become equal as there won't be any time value left in the future contract.
Let us see the payoff on expiry day:
Case 1: INFY closes at 600
Cash Market - No loss
Futures - Rs. 5 profit

Case 2: INFY closes at 620
Cash Market - Rs. 20 profit
Futures - Rs. 15 loss

Case 3: INFY closes at 580
Cash Market - Rs. 20 loss
Futures - Rs. 25 profit
Hence, in any case, the fund makes profit and this profit is limited to the difference between the prices between 2 markets at the time of entering the trade.

Arbitrage funds are not allowed to take any naked/unhedged exposures.
These funds also have mandate to invest in short term debt instruments when the arbitrage opportunities are scares in equity markets. However they invest in debt instruments with maturity of less than 91 days hence the interest rate risks are also mitigated.
Special situations like Dividend Arbitrage & Buyback Arbitrage are also allowed.

The return profile of these funds looks more or less like debt funds however, major risk is unavailability of such arbitrage opportunities in the market which would make things tough for the scheme.
Arbitrage funds are treated as equity from the taxation point of view which creates a positive impact on returns for individuals in certain tax slab as the long-term capital gains has lower or no tax impact.

Tip: Investment horizon should be at least 3 months for this category.
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Finsense Gurukul
@FinsenseG
Factsheet of a Mutual fund scheme is the most important document which should be read by an investor before taking a call on investing in it.

A thread on "How to read a Factsheet of Equity Scheme"

#mutualfunds
Investment Objective: This indicates the objective of the scheme and also gives an idea about where the scheme is going to invest. In above case, the scheme is planning to invest predominantly in large cap stocks as it is a Large cap category fund.
Date of Allotment: Launch date or NFO date of the scheme.

AUM: Asset Under Management is the total amount of money being managed under the scheme.
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Finsense Gurukul
@FinsenseG
Thread: Cost of Funds & Net Interest Margins

COF is the implied interest rate paid by the bank on the funds that it uses in it's business. Banks get these funds from sources like Savings & Current Accounts (Cheapest sources), Fixed Deposits, Bonds, Debt instruments etc.
Eg: A Bank has deposits of Rs. 100 (on which it pays 6%) and bonds of Rs. 100 paying 7% and thus the weighted average cost of funds for them comes to be 6.5%. In a nutshell, it is the cost of funds.

Now the bank has to lend money at a rate higher than its COF to make profits.
This profit margin is denoted by Net Interest Margins (NIM)
Let's understand NIMs:
Net Interest Margin is difference between investment returns earned and interest paid divided by Average Earning Assets.
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Finsense Gurukul
@FinsenseG
Why are NPAs so widely tracked?

Because if a sizeable percentage of the loan book of a Bank becomes NPA, the equity portion gets hit of the Bank (because remember deposits have to be returned with interest and some money is in CRR/SLR, so the direct hit is to equity).
Due to big sized NPAs, equity value can get hit, and if equity value gets hit, the stock price can get hit badly and also limits the growth of the bank.
Example – Bank has Rs. 80 of deposits, Rs. 20 of equity. Its loan book is Rs. 80 (suppose) and if 10% becomes NPA, out of 80, so that translates into Rs. 8 NPA. Since the bank has to pay back deposits with interest, the banks’ equity value gets hit.
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