NISM V-A Chapter 7: Net Asset Value, Total Expense Ratio and Pricing of Units — Practice Questions
This chapter addresses the critical mechanics of mutual fund unit valuation and cost structures under SEBI regulations. Net Asset Value (NAV) represents the per-unit price calculated as (Total Assets - Total Liabilities) / Number of Outstanding Units, and must be disclosed daily for open-ended schemes. Understanding NAV calculation is fundamental as it determines your entry and exit prices in mutual funds. Total Expense Ratio (TER) is the maximum percentage of average assets under management that funds can charge annually, varying by asset class and fund category under SEBI guidelines—lower TER directly enhances investor returns. Pricing of units involves forward pricing mechanisms where purchase and redemption requests are processed at NAV declared after application closure, protecting against timing arbitrage. Test-takers must distinguish between direct plan NAVs (lower expense ratios) and regular plans, grasp TER calculation methodology, and recognize how expense caps impact fund performance across equity, debt, and hybrid categories. This chapter is exam-critical as NAV and TER questions frequently appear in calculations and regulatory compliance sections.
Q1. What does 'Total Assets' include in the NAV calculation?
ANSWER
Option B
EXPLANATION
Total Assets in NAV calculation includes: market value of all portfolio investments (equity at last traded price, debt at valuation agency prices), accrued income (interest, dividends declared but not received), cash and bank balances, and other receivables. This comprehensive valuation ensures NAV reflects all value within the scheme.
Q2. What does 'Total Liabilities' include in the NAV calculation?
ANSWER
Option B
EXPLANATION
Total Liabilities in NAV calculation includes: accrued but unpaid expenses (TER components — management fees, custodian fees, RTA fees, audit fees), amounts payable for securities purchased but not yet settled, outstanding redemption payables, and other liabilities. These are deducted from total assets to arrive at net assets.
Q3. What is the 'redemption price' for an open-ended scheme?
ANSWER
Option B
EXPLANATION
Redemption Price = Applicable NAV − Exit Load (if applicable). If a scheme has 1% exit load for redemptions within 1 year and the NAV is ₹100, the redemption price is ₹99 per unit. After the exit load period, redemption price = NAV. The exit load amount goes back to the scheme corpus, not to the AMC.
Q4. What is the 'cut-off time' for equity scheme transactions and its impact on NAV applicability?
ANSWER
Option B
EXPLANATION
For equity, hybrid, and most debt schemes, the cut-off time is 3:00 PM. Transactions (purchase/redemption/switch) submitted before 3 PM with funds received by the AMC also before 3 PM get that business day's closing NAV. Transactions submitted after 3 PM get the next business day's NAV. This rule prevents investors from exploiting intraday price movements.
Q5. How is TER deducted from investors in practice?
ANSWER
Option B
EXPLANATION
TER is deducted on a daily basis from the scheme's portfolio returns before the NAV is calculated. If a scheme earns 12% gross and TER is 1.5%, the NAV growth investors see is approximately 10.5%. Investors never receive a separate bill — the cost is seamlessly embedded in the daily NAV. This makes TER invisible but compoundingly significant over long periods.
Q6. What are the maximum TER limits for debt schemes compared to equity schemes?
ANSWER
Option B
EXPLANATION
Debt scheme TER limits are lower than equity at each AUM slab — reflecting lower management costs and distributor margins in debt vs equity. The maximum for debt is 2.00% for first ₹500 crore (vs 2.25% for equity), stepping down similarly as AUM increases. Liquid and overnight funds have the lowest TER limits among all categories.
Q7. What additional TER is permitted for inflows from B-30 cities?
ANSWER
Option C
EXPLANATION
SEBI allows AMCs to charge an additional TER of up to 0.30% per annum on the AUM from B-30 (beyond top 30) cities. This additional charge is meant to incentivise distributors to expand reach to smaller cities — the additional TER revenue is shared with distributors as higher trail commission. The 0.30% is over and above the regular TER limit.
Q8. What costs can legitimately be included in the TER of a mutual fund scheme?
ANSWER
Option B
EXPLANATION
SEBI prescribes what can be charged to the scheme within TER: investment management and advisory fees, marketing/distribution expenses (capped component), brokerage on portfolio transactions, custodian fees, RTA fees, audit fees, trustee fees, and investor education expenses (0.02% mandatory). Costs like penalties/fines, AMC's own overhead, and legal costs for AMC-level disputes cannot be charged to the scheme.