FINANCE guru SPEAKS!

Know About Tax-Free Incomes!

2008-06-15T12:41:00.002+05:30

FINANCE guru SPEAKS: The following are some important items of income, which are fully exempt from income tax and which a resident individual Indian assessee can use with profit for the purpose of tax planning.

1. Agricultural income
Under the provisions of Section 10(1) of the Income Tax Act, agricultural income is fully exempt from income tax. However, for individuals or HUFs when agricultural income is in excess of Rs 5,000, it is aggregated with the total income for the purposes of computing tax on the total income in a manner which results into "no" tax on agricultural income but an increased income tax on the other income.

2. Receipts from Hindu Undivided Family (HUF)
Any sum received by an individual as a member of a Hindu Undivided Family, where the said sum has been paid out of the income of the family, or, in the case of an impartible estate, where such sum has been paid out of the income of the estate belonging to the family, is completely exempt from income tax in the hands of an individual member of the family under Section 10(2).

3. Share from a partnership firm
Under the provisions of Section 10(2A), in the case of a person being a partner of a firm which is separately assessed as such, his share in the total income of the firm is completely exempt from income tax since AY 1993-94. For this purpose, the share of a partner in the total income of a firm separately assessed as such would be an amount which bears to the total income of the firm the same share as the amount of the share in the profits of the firm in accordance with the partnership deed bears to such profits.

4. Allowance for foreign service
Any allowances or perquisites paid or allowed as such outside India by the Government to a citizen of India, rendering service outside India, are completely exempt from tax under Section 10(7). This provision can be taken advantage of by the citizens of India who are in government service so that they can accumulate tax-free perquisites and allowances received outside India.

5. Gratuities
Under the provisions of Section 10(10) of the IT Act, any death-cum-retirement gratuity of a government servant is completely exempt from income tax. However, in respect of private sector employees gratuity received on retirement or on becoming incapacitated or on termination or any gratuity received by his widow, children or dependants on his death is exempt subject to certain conditions.

6. Life insurance receipts
Under Section 10(10D), any sum received under a Life Insurance Policy (LIP), including the sum allocated by way of bonus on such policy, other than u/s 80DDA or under a Keyman Insurance Policy, or under an insurance policy issued on or after 1.4.2003 in respect of which the premium payable for any of the years during the term of the policy exceeds 20 per cent of the actual capital sum assured, is fully exempt from tax.
However, all moneys received on death of the insured are fully exempt from tax. Thus, generally moneys received from life insurance policies whether from the Life Insurance Corporation or any other private insurance company would be exempt from income tax.

7. Dividends on shares and units -- Section 10(34) & (35)
With effect from the Assessment Year 2004-05, the dividend income and income of units of mutual funds received by the assessee completely exempt from income tax.

8. Long-term capital gains of transfer of securities -- Section 10(38)
With effect from FY 2004-05, any income arising to a taxpayer on account of sale of long-term capital asset being securities is completely outside the purview of tax liability especially when the transaction has been subjected to Securities Transaction Tax (STT).
Thus, if the shares of any company listed in the stock exchange are sold after holding it for a minimum period of one year then there will be no liability to payment of capital gains. This provision would even apply for the old shares which are held by an assessee and are sold after the Finance (No.2) Act, 2004 came into force.

9. Scholarship and awards, etc
Any kind of scholarship granted to meet the cost of education is exempt from tax under Section 10(16). Similarly, certain awards and rewards, etc. are completely exempt from tax under Section 10(17A). Any daily allowance received by a Member of Parliament or by an MLA or any member of any Committee of Parliament or State legislature is also exempt from tax under Section 10(17).

10. Payment received from provident funds
Under the provisions of Sections 10(11), (12) and (13) any payment from a government or recognised provident fund (PF) or approved superannuation fund, or PPF is exempt from income tax.

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All About Equity-linked Debentures!

2008-06-07T11:52:00.004+05:30

FINANCE guru SPEAKS: Recently, some asset management companies have launched structured products for retail investors. A look at how they work.

The party is over for investors. Equities markets are being hammered badly. And there is general unrest all around. As usual, now that they are hurt, investors are looking at low risk options, which would protect their principal amount at least.

What are the available options? There are small savings and bank deposits. The dismal post-tax returns, however, are a serious deterrent. The other alternative is a fixed maturity plans (FMPs) of mutual funds which are tax- efficient, but give low returns.

Of course, equities can still be a great option. A word of caution though, we are unlikely to see the breathtaking speed with which market took off during the last few years and there will be intermittent volatility and pain.

For the high net worth individuals, Portfolio Management Services (PMS) investors there are structured products called the equity-linked debentures. These give you the upside of equities and protect the downside.

Popularly know as capital protection funds, mutual funds are now making these products available to retail investors as well. ICICI Prudential asset management company (AMC) launched their Nifty-linked FMP a closed-ended product and now Deutsche AMC has launched a similar product.

The actual terms of these products may vary slightly, but the broad theme of the product works in this manner.

These index linked fixed maturity plans are linked to an index like the Nifty or Sensex. The AMC invests a pre-determined part of the monies collected in fixed income securities, which could be between 15 per cent and 25 per cent.

The balance is invested in equity-linked debentures (ELDs). These ELDs are floated by many issuing banks like Citibank, Deutsche bank, Merrill Lynch, Kotak bank and others. ELDs are floating rate debt instruments whose coupon (interest) is based on the return of the underlying equity index.

The ELD's will generally return the principal on maturity. A word of caution though: always assess the creditworthiness of the issuer should be done before investing.

The return on the underlying specified index will be calculated on the basis of the terms of the ELD. For instance, in case of Deutsche equity-linked three year and S&P CNX Nifty-linked FMP, the returns of the product will be computed, based on formulas.

Though there is no guarantee of principal in these products, it is improbable that your principal will be eroded because the credit quality of the issuer is good.

Of course, there are other Nifty- linked PMS products where the principal is protected and there is a guarantee as well. There are charges for such a guarantee, which is a flat fee of 4 per cent to 5 per cent. Premature redemption may be possible with a heavy exit load. They may even be listed on the stock exchange. Long-term capital gains with the benefit of indexation will be applicable for these products.

To summarise, if an investor invests in these schemes their downside risk of capital erosion is protected (promised - not assured) and on the upside, they may get a return in-line with the appreciation of Nifty. At worse, you don't lose your capital.

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Post Office Monthly Income Scheme!

2008-06-06T13:34:00.001+05:30

· Who can open an account

Only resident Indians can open accounts under the scheme. Even more than one account can be opened provided total deposits in all the accounts do not exceed Rs 450,000 in a single account and Rs 900,000 in joint account. There can be only one deposit in the account, which should be a minimum of Rs 1,500 or multiple thereof.

· Nomination

There is a facility of nomination.

· Maturity

The maturity period for deposits under the scheme is 6 years.

· Interest

Deposits earn an interest of 8% per annum and payment is made every month in cash or deposited in the post office savings account, at the option of depositors. Also deposits made after December 8, 2007, are eligible for a 5% bonus (of the initial amount invested) on maturity.

· Tax benefit

Investments in Post Office Monthly Income Scheme are not eligible for any tax benefits.

· Wealth Tax

The deposits are exempt from Wealth Tax.

· Withdrawals

Permitted after 1 year from the date of making the investment. If the premature withdrawal is made after 1 year, but before 3 years, then 2% of the initial amount invested is deducted as a penalty. Similarly, a premature withdrawal after 3 years will attract a penalty of 1% of the initial amount invested. In case of death of a depositor before maturity, the account may be closed and the deposited amount refunded to the nominee/heir along with interest upto the month preceding the month in which refund is made.

· Transfer of Account

Account can be transferred from one post office to another.

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All About Kisan Vikas Patra!

2008-06-04T18:55:00.004+05:30

· Who Can Apply

Any adult individual can purchase Kisan Vikas Patra (KVP) in his or her name (single holder type) or jointly with another adult individual with the condition 'jointly or survivor' (A type) or 'either or survivor' (B type). Besides, parents and guardians can also purchase on behalf of a minor. NRIs are not permitted to invest in KVP.

· Where to Apply

Application for the certificate can be made to all departmental post offices authorised to transact saving bank business.

· How to Apply

The application can be made in the prescribed form along with the payment that has to be deposited with the post office directly or through its authorised agents.

· Investment Limits

There is no investment limit in this scheme and individuals can invest any amount they wish. Minimum investment required is Rs 100.

· Denomination

Investments can be made in the denominations of Rs 100, Rs 500, Rs1000, Rs 5000, Rs 10000, from any of the post offices and in denomination Rs 50000 from all head post offices.

· Interest Rate

This scheme doubles the investor's money in 8 years 7 months with an option of premature encashment.

· Maturity

The scheme matures in 8 years 7 months. For example if an individual buys the certificate by investing Rs 1,000 his money will become Rs 2,000 on maturity.

· Tax Benefit

Investments in KVP do not offer any tax benefits to the investors.

· Loans

Kisan Vikas Patra has been declared as "Public Security" by the Government of Maharashtra. Certificate holders can avail loan from banks against the certificates.

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Senior Citizens Savings Scheme

2008-05-14T11:07:00.002+05:30

FINANCE guru SPEAKS: This blog will throw light on Senior Citizens Savings Scheme. Just go through the post and get informative!

Who Can Apply

The scheme is available for citizens above 60 years of age; however a provision has been put in place for individuals who have crossed 55 years of age. Such individuals may invest subject to the conditions that,

The person has retired on superannuation or otherwise on the date of making the investment; also the investment is made within one month of the date of receipt of retirement benefits.
A certificate from the employer, indicating the fact of retirement, retirement benefits, along with period of such employment with the employer, is attached with the application form.
The maximum amount invested can either be the benefits received on retirement or Rs 1,500,000 whichever is lower.
NRIs (Non-Resident Indians) and HUF (Hindu Undivided Families) are not permitted to invest in the scheme.

Investment Limits

Investments can be made in any post office by opening an account. Only one deposit can be made in each account; the deposit amount shall be a multiple of Rs 1,000 and should not exceed Rs 1,500,000.
A depositor can operate more than one account subject to the condition that all the deposits taken together don't exceed the specified amount i.e. Rs 1,500,000. Also more than one account shall not be opened in the same post-office during a calendar month.

Interest Rate

The scheme will offer an interest of 9% per annum. The same will be payable on 31st March, 30th June, 30th September and 31st December each year.

Mode of holding

The depositor can hold an account either individually or jointly with his/her spouse.

Nomination

Nomination facility has been provided under the scheme. In the event of death of the depositor, the amount due shall be paid to the nominee. Nomination facility is also available incase of joint accounts.

Maturity

The scheme has a tenure of 5 years. The account can be extended for a 3 year period by making an application.

Withdrawals

Investors will be permitted to prematurely liquidate their investments at any time after the expiry of 1 year from the date of opening of the account subject to the following conditions,

In case the account is closed after the expiry of 1 year but before the expiry of 2 years from the date of opening of the account, an amount equal to 1.5% of the deposit shall be deducted.
In case the account is closed on or after the expiry of 2 years from the date of opening of the account, an amount equal to 1% of the deposit shall be deducted.

Tax Benefits

Investments in the scheme are eligible for tax benefits under Section 80C of Income Tax Act.
The interest income from the scheme is fully taxable and subject to TDS (tax deduction at source) as well. Investors whose tax liability on the estimated income for the financial year is nil, can avoid TDS by furnishing a declaration in Form 15-H or Form 15-G as applicable.

Transfer of Account

The account can be transferred from one post office to another. If the deposit amount exceeds Rs 100,000, a transfer fee of Rs 5 per Rs 100,000 deposited is charged.

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How To Save Income Taxes!

2008-05-12T12:16:00.004+05:30

FINANCE guru SPEAKS: Section 80C is the not the only section under which you get tax benefits, there are some other sections as well.

The Income tax Act, 1961 contains several provisions which can serve as tools for saving your tax outgo. While everyone is more focused on meeting the 80C limits, here are a few more options.

Section 10 (35): This section grants exemption on long-term gains from mutual funds (if they are held for more than a year). Interestingly, the government taxes the interest income on our balance in savings banks and fixed deposits according to the income bracket.

The interest income is taxed in such a manner that only two-thirds of the interest earned is left in the hands of the tax payer if he falls in the highest tax bracket of 33.99 per cent (30 per cent + 10 per cent SC + 3 per cent cess), exceeding Rs 10 lakh. Similarly, post office savings bank interest is fully exempt under section 10(11).

Section 10 (38): This section gives benefits to investors in listed equity shares for more than a year. However, it is important to note that there is a distinction between 365 days and 12 months. Any scrip purchased on April 7, 2007 will complete 365 days on April 8, 2008 but not 12 months.

Courts have laid down that 12 clear months will be completed only on May1, 2008. Hence, the capital gain will be long-term, only when sold on or after 1 May 2008. If someone sells the shares after April 8, 2008 but before May 1, 2008, it will be treated as short-term and not eligible for exemption, even though the securities transaction tax(STT) is duly paid.

Section 80D: This section provides tax relief with respect to medical insurance premium. Union Budget 2008-09 has expanded the scope of this section by increasing the limit. Now, a person can get an additional benefit of Rs 15,000 for self, spouse, children and dependent parents.

Thus, a total tax relief of Rs 30,000 is now possible now. Also, if any of the two parents are above the age of 65 years, the deduction goes up to Rs 20,000. It is not necessary that the parents should be dependent on the taxpayer. It is important to remember though that the payments for the policies should be made by cheques and not in cash or by credit card.

Section 54EC: This section grants long-term capital gains exemption on any asset when the gains are invested within the next six months in the bonds of Rural Electrification Corporation or of National Highways Authority of India.

Last year's Budget, with effect from assessment year 2007-2008, (financial year 2006-2007) had put a ceiling of Rs 50 lakh as the amount that could be invested in such instruments by a taxpayer. But closer reading of the restrictions suggests that the ceiling is with reference to investment in a single financial year only.

In other words, if the investments are so made that they fall in two financial years, the ceiling of Rs 50 lakh could be raised to Rs 1 crore.

To illustrate, let us suppose that the long-term capital gain of Rs 1 crore arises on December 7, 2007, then the taxpayer can invest Rs 50 lakh before March 31, 2008 and another Rs 50 lakh after April 1, 2008 but before May 7, 2008, so that the time between gains and investment do not exceed six months from the sale date of December 7, 2007.

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How To Invest Directly in Mutual Funds!

2008-05-11T13:56:00.005+05:30

FINANCE guru SPEAKS: If the application form for buying units is filled in and submitted by the investor directly at the asset management company's (AMC) office or an investor service centre or specified collection centre, the investor need not pay the entry load. If the fund has the option of buying units online, that too is considered "Direct Investment".

An investor can invest directly in a mutual fund in three different ways:

LOCATE THE NEAREST OFFICE OF THE AMC IN YOUR CITY.

Visit the office, fill up the form and submit the documents. Your bank does not double up as a branch office for the mutual fund house. The bank and the mutual fund house, in spite of belonging to the same group, are two different entities.

CHECK FOR COLLECTION CENTRES OR INVESTOR SERVICE OFFICES

If the AMC does not have an office, collection centre or investor service office in the city, you may have to courier your form. If the cost of the courier is the same as the entry load, it would make sense to hire an agent and save yourself the trouble.

APPLY ONLINE

Visit the web site of that particular fund house and see if they offer an online option. Here you will need to fill up your personal and investment details as asked in the application form and quote your Permanent Account Number (PAN), which is mandatory. When investing online, mutual funds tie up with various banks for transfer of money. Do check that your bank is on that list.

Another option is to the payment through a cheque/demand draft. In that case, you would need to courier the same. In case you opt for a systematic investment plan (SIP) you can choose the Electronic Clearance Scheme (ECS). Some fund houses do not offer SIP investments, online. You would have to go to a branch to do the same.

Also remember, that an agent will take care of all the paper work and will also be around if you need help at redemption.

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Myths About NAV of Mutual Funds!

2008-05-09T13:59:00.002+05:30

FINANCE guru SPEAKS: The NAV of a mutual fund has not been correctly understood by a large section of the investing community.

This is quite evident from the fact that Mutual Funds had been recently collecting huge corpus in their New Fund Offers or NFOs, whereas the collections in the existing schemes were negligible. In fact, investors sold their existing investments and invested in NFOs. This switch makes no sense, unless the new fund has something different and better to offer.

Misconception about NAV

This situation arises from the perception that a fund at Rs 10 is cheaper than say Rs 15 or Rs 100. However, this perception is totally wrong and investors would be much better off once they appreciate this fact. Two funds with same portfolio are same, no matter what their NAV is. NAV is immaterial.
Why people carry this perception is because they assume that NAV of a MF is similar to the market price of an equity share. This, however, is not true.

Definition of NAV

Net Asset Value or NAV is the sum total of the market value of all the shares held in the portfolio including cash less the liabilities, divided by the total number of units outstanding. Thus, NAV of a mutual fund unit is nothing but the ‘book value’.

NAV vs Price of an Equity Share

In case of companies, the price of its share is ‘as quoted on the stock exchange’, which apart from the fundamentals, is also dependent on the perception of the company’s future performance and the demand-supply scenario. And hence the market price is generally different from its book value.

There is no concept as market value for the MF unit. Therefore, when we buy MF units at NAV, we are buying at book value. And since we are buying at book value, we are paying the right price of the assets whether it be Rs 10 or Rs.100. There is no such thing as a higher or lower price.

NAV & It’s Impact on the Returns

We feel that a MF with lower NAV will give better returns. This again is due to the wrong perception about NAV. An example will make it clear that returns are independent of the NAV.
Say you have Rs 10,000 to invest. You have two options, wherein the funds are same as far as the portfolio is concerned. But say one Fund X has an NAV of Rs 10 and another Fund Y has NAV of Rs 50. You will get 1000 units of Fund X or 200 units of Fund Y. After one year, both funds would have grown equally as their portfolio is same, say by 25%. Then NAV after one year would be Rs 12.50 for Fund X and Rs 62.50 for Fund Y. The value of your investment would be 1000*12.50 = Rs 12,500 for Fund X and 200*62.5 = Rs 12,500 for Fund Y. Thus your returns would be same irrespective of the NAV.

It is quality of fund, which would make a difference to your returns. In fact for equity shares also broadly this logic would apply. An IT company share at say Rs 1000 may give a better return than say a jute company share at Rs 50, since IT sector would show a much higher growth rate than jute industry (of course Rs 1000 may ‘fundamentally’ be over or under priced, which will not be the case with MF NAV).

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ULIPs v/s Mutual Funds!

2008-05-08T20:29:00.003+05:30

FINANCE guru SPEAKS: Unit Links Insurance Plans (ULIPs) and Mutual Funds (MF) are the two most preferred options for a part time investor to invest into equity. But how do we decide which one should we go for. Though it is very easy to decide, people tend to confuse themselves most of the time.

This article talks about some points that you need to consider while deciding which option we want to take. Mutual Fund are pure investments. ULIPs are combination of Insurance and Investment.

First question that we need to answer while buying ULIPs is - Do I need to buy insurance?

1) Does the person seeking insurance have any financial liabilities?

2) If something happens to the person, Is there someone who can be in a financial crisis? If the answer to the above two question is YES, I NEED TO BUY INSURANCE.

Now let us compare ULIPs and MF based on certain well known facts:

1) Insurance ULIPs provide you with insurance cover. MFs don't provide you with insurance cover. A point in favor of ULIPs. But let me tell you that you don't get this insurance cover for free. Mortality charges (i.e. the price you pay for the insurance cover) get deducted from your investment.

2) Entry Load: ULIPs generally come with a huge entry load. For different schemes, this can vary between 5 to 40% of the first years premium. MFs have a small entry load of a maximum of 2.25% which can also be waived off if you apply directly (i.e. not through a agent). Here MFs have a huge advantage. If we consider a conservative market return of about 10-15% you may get a zero percent return in the first year.

3) Maturity: ULIPs generally come with a maturity of 5 to 20 years. That what ever money you put in, most of it will be locked-in till the maturity. Tax saving MF (Popularly called as Equity Linked Saving Scheme or ELSS) come with a lock-in period of 3 years. Other MFs don't have a lock-in period. Again MFs have advantage over ULIPs. ULIPs do allow you to take money out prematurely but they also put penalties on you for doing that.

4) Compulsion of Investing: ULIPs would generally make you pay at least first three premiums. MFs don't have any compulsion on future investments. If you have invested in a MFs this year, and in the next year you dont have enough income or money to do investments you can decide not to make any investmets. Also if you notice that the MFs that you invested in is not giving good returns as compared to some other Funds scheme, you can decide to invest in some other MF.

5) Tax Saving: Both the ELSS and ULIPs come under 80C and can save you tax. Returns in the both form of investments are tax free.

6) Market Exposure: ULIPs give you both moderate and aggressive exposure to equity market. Debt and Liquid MF let invest with low risk, but don't give you tax benefit. ULIPs need not be aggressive in equity exposure. That is ULIPs need not keep more that 60% of their funds in equity market. ULIPs also allow to change your equity market exposure. Thus it can help you time the market and still give you tax savings. If a MF has a less than 60% exposure to equilty market the returns from it are not tax free. Thus you don't get to take a conservative stand on returns.

7) Flexibility of time of Redemption: ULIPs will get redeemed on maturing. Premature redemption is allowed with some penalty. In MF, Premature redemption is not allowed. For a open ended scheme one can redeem the MF anytime after maturiry. This is mainly useful if the market is down at the maturity time of the investment. In case of ELSS you can wait till the market comes up again and then redeem them. ULIPs scheme won't allow you to wait.

Thus, According to our opinion:

1) If you wish to take a agressive exposure to equity market, go ahead any buy MF. ULIPs wont be able to give you similar returns.

2) If you think you are not disciplined enough to make regular investments and need a whip to make you invest, invest in ULIPs. However, you can do the same in MF through Systematic Investment Plan (SIP).

3) If you want to take a low exposure to equity market and still get tax free returns, invest in ULIPs but make sure that fund you are invested is conservative fund. The same can be achieved in MF through Liquid or Balanced Funds.

4) If you want Insurance cover and also good return on investment. I would suggest that you invest in MFs and take a Term Insurance Plan.

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Know About Kotak Sensex ETF!

2008-05-07T18:18:00.004+05:30

FINANCE guru SPEAKS: Kotak Mutual is launching Kotak Sensex ETF on May 7, 2008. This exchange traded fund will track BSE Sensitive Index (Sensex) to provide returns before expenses that closely correspond to the total returns of the BSE Sensex. The fund is open for subscription from May 07, 2008 till May 16, 2008. The units would be listed on BSE to provide liquidity through secondary market.

This will be the second ETF on Sensex. The first ETF on Sensex was launched in January 2003 -- ICICI Pru Spice which has closely tracked Sensex and delivered returns as much as the Sensex in the past 5-years but currently has less than Rs 1 crore assets under management.

ETF is an Index fund but they trade on the market like stocks. Kotak Sensex ETF will facilitate exposure to Sensex with a single order. It will also enable trading flexibility by Intra day buying and selling just like any other listed share. The pricing will also be almost live as the intraday indicative price is likely to be closely linked to Sensex.

Index funds have lower cost as they charge lower management fee compared to actively managed funds. Investors will have to pay brokerage in buying and selling these instead of any entry/exit load.

Other Details:

Each unit of the Kotak Sensex ETF will be approximately equal to 1/100th of the value of BSE SENSEX.
Entry Load during NFO: For investments < investments =" "> Rs 1 Crore: Nil.
No entry load shall be charged on all direct applications received by AMC i.e., on application forms that are not routed through any distributor / agent / broker and submitted to AMC office or collection centre / investment service centre.
Entry Load during continuous offer : Nil
Exit Load: Nil

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Myths About Mutual Funds!

2008-05-07T17:26:00.002+05:30

FINANCE guru SPEAKS: Mutual funds have witnessed a marked growth in popularity over the past few years. Statistics reveal that retail investors have increasingly warmed up to the idea of investing in mutual funds. However this has given rise to its own set of not-so-pleasant trends. It can be safely stated that there is a large amount of disinformation about mutual funds doing the rounds. And when investors act on such flawed information, it leads to incorrect investment decisions.

Myth 1: All Diversified Equity Funds are Diversified

Theoretically, one would expect a diversified equity fund to live up to its proposition of being diversified i.e. to freely invest in stocks from across market segments (large, mid and small cap stocks). Furthermore, the fund should also hold a portfolio encompassing several sectors. However, this is rarely the case. More often than not, equity funds have a bias for a particular segment like large caps or mid caps. Also, diversified equity funds are known to take sectoral bets i.e. hold a significant portion of their portfolios across a few sectors. To further complicate matters, even the investment objective and/or the Offer Document may not reveal the fund's investment biases.

Learning: In the mutual funds segment, not everything is what it seems. Don't take the nomenclature i.e. diversified at face value while getting invested. Instead study the fund's portfolio over a period of time and across market cycles to better understand its true investment style. Also the sales and promotional literature issued by the fund house can provide insights into a fund's investment proposition.

Myth 2: Funds that Regularly Declare Dividends make Good Buys

For some time now, declaring dividends has become a marketing ploy that fund houses utilise to attract investors. In fact the phenomenon is so prevalent that regulations have been put in place to govern the manner in which dividends are declared. Notwithstanding the aforementioned, investors continue to believe that any fund which regularly declares dividends makes a good buy.
Dividends are declared by a fund house subject to availability of a distributable surplus and at the latter's discretion. Hence, it is typically assumed that the dividends are indicators of the fund's strong performance; this need not always be true. For instance, there is a possibility that the fund manager has run out of investment opportunities, so he has chosen to distribute the available surplus among investors rather than invest it. Or even worse, the fund might have sold some of its best stocks rather prematurely to generate cash for the dividends, since the larger motive was to attract investors by declaring dividends.

Learning: We aren't suggesting that there is an ulterior motive behind every dividend declared. However, a fund's dividend history is certainly not a factor to base an investment decision on. Instead, you must consider the fund's investment proposition and performance across the risk and return parameters over longer time frames, and its suitability in your portfolio, among a host of other factors before making an investment decision.

Myth 3: An FMPs performance can Never turn Negative

A fixed maturity plan (FMP) is the fixed deposit equivalent from the mutual funds segment. Despite its market-linked nature, the return that an FMP will offer on maturity is known with a reasonable degree of certainty at the time of investing. This is done by locking-in the yield at the time of investment over the FMPs close-ended (read defined) tenure.
Now the key is that the investor stays invested until the FMPs maturity; by doing so he will be on course to receive the proposed return. However, in the interim period, factors like a change in the interest rate scenario or rising inflation could push the FMPs performance into negative territory.

Learning: Don't push the panic buttons if your FMP investment turns negative in the interim; it is structured to deliver the indicative return on maturity. The operative words being on maturity and not in the intermittent period. So long as the FMPs portfolio is dominated by instruments of the AAA/equivalent variety (thereby eliminating any credit risk) and you stay invested for the entire tenure, you can afford to be indifferent to a negative performance in the interim.

Myth 4: SIPs Always Score over Lump Sum Investing

The systematic investment plan (SIP) mode of investing entails investing smaller amounts in a staggered manner. The intention is to gain from market volatility by lowering the average purchase cost. Since the investment amount for each installment is fixed, the investor gains by receiving a higher number of mutual fund units every time the markets fall.
However, an SIP may fail to lower the average purchase cost should the markets rise in a secular manner over the SIP's tenure. Such a scenario cannot be ruled out over shorter time frames. In effect, a lump sum investment could prove to be more cost-effective vis-a-vis an SIP investment in a rising market scenario.

Learning: For an SIP to be successful (as opposed to a lump sum investment), having a long-term investment tenure is pertinent. Hence, while investing via the SIP mode, opt for a tenure of at least 12-24 months.

Myth 5: A Lower NAV makes a Cheaper Buy

This could well rank as the mother of all mutual fund myths. Perhaps as old as the new fund offer (NFO) phenomenon itself, nonetheless, investors continue to believe that buying into a fund with a lower net asset value (NAV) makes a cheaper buy and vice-versa.
In stocks, the book value and the market value can be distinct from one another, leading to a cheap or expensive buy. However, in mutual funds, the NAV represents the asset value backing each unit i.e. the intrinsic worth of each unit. As a result, the concept of a lower NAV making a cheaper buy vis-a-vis a higher NAV is fundamentally flawed. Sadly, fund houses and investment advisors have over the years milked this myth to the hilt in order to sell NFOs to gullible investors.

Learning: Don't let a fund's NAV influence your investment decision. Instead, evaluate the fund on parameters like its track record, investment processes followed by its fund house and suitability for you, among others.

For more Learning,Please visit "AT A GLANCE" Section.

Disappointed with Reliance Equity Fund!

2008-03-30T10:12:00.004+05:30

FINANCE guru SPEAKS: Are You disappointed by Reliance Equity Fund (REF)? This is the equity scheme that created history by collecting the maximum amount (Rs 5,759 crore) in its new fund offer (NFO) period in March 2006. Further, it became the largest equity fund at that time without investing a penny in the market. Market sources told us that so happy was Anil Ambani, chairman of Reliance Capital, the sponsor of Reliance Asset Management, that he awarded a Mercedes Benz each to Amitabh Chaturvedi, then chief executive officer, and Madhusudan Kela, head, equity, Reliance Mutual Fund. Things are not quite the same, in 2007 REF lost Rs 2,293.20 crore or 40 per cent of its NFO collections between the time its NFO period ended and September 2007. Close to 17.77 billion units had been redeemed from REF up to March 2007 the last time mutual funds declared their half-yearly results as its unit capital stood at Rs 3,949.92 crore, down from Rs 5,727.17 crore in March 2006. The industry practice is to disclose results for the six-month period ending September by October-end. That's when REF, too, is likely to come out with its results, but we do not expect the picture to get any brighter. The returns of REF in the year ended 15 October 2007 were lower than both the average returns of 47.20 per cent of diversified equity funds and the 53.90 per cent that REF's own benchmark index Nifty returned.

The Real Story

On the face of it, REF looks like many other diversified equity funds in the market. It invests in the top 100 companies by market capitalisation and also in companies in the derivatives segment. This is where the similarity ends. Unlike most other equity funds, REF also hedges its portfolio. The amount of its portfolio that it can hedge depends on the Nifty's price-to-earnings (PE) ratio. If the Nifty's PE ratio is 12, REF will hedge up to 10 per cent of its portfolio; if the Nifty's PE ratio is between 12 and 16, it will hedge between 10 and 30 per cent of its portfolio, and so on, as indicated in its offer document. This caps the upside potential of the fund, but limits the downside should equity markets tumble. Further, REF can also take derivatives exposure in stocks that it does not hold. This heightens REF's risks and only time will tell how effectively REF will be able to use derivatives to protect its downside.

Short of Expectations

Investors failed to recognise this attribute. REF is bound by its offer document to hedge its portfolio depending on the Nifty's PE. To that extent, REF is passively-managed. However, the Nifty went up by 38 per cent and diversified equity funds that did not hedge their portfolios outperformed REF, on an average. Investors expecting great returns from REF were disappointed and many of them exited it.Sources claim that since REF was the first equity NFO after the Reliance empire split, there was a need to prove a point. What followed was aggressive marketing and collections that helped the mutual fund jump to the number two slot in the corpus race, up from number five a month back. Mutual fund agents mobilised a substantial amount of short-term money too ,a frequent scene in an open-ended NFO. And as REF charges 4.1 per cent NFO expenses to be amortised over five years remember, it's an open-ended scheme existing investors will take a hit.

What should you do?

The equity markets are expected to be volatile and REF's strategy will yield results only if you're in for the long haul. Avoid REF if you are looking for pure equity returns. If you want some kind of protection to seep into your equity funds, REF is the perfect and most systematic way to go about it. With volatility having gripped the global and Indian markets, this fund could prove to be a useful companion. Stay invested.

For more Learning, Please Visit "AT A GLANCE" Section.

Retirement Planning Through Mutual Funds!

2008-01-23T21:03:00.000+05:30

Finance guru Speaks: Any investor with a long -term investment plan for retirement cannot give equities a miss. And any investor who plans to invest in equities cannot give mutual funds a miss. That is why mutual funds have a critical role to play in your retirement planning portfolio. Mutual funds and retirement planning have enough points in common to make them perfect for each other.

Consider this - retirement planning is about investing for the long- term, at times for even longer than 35 years. Mutual funds (equity -oriented funds to be more precise) are also about investing for the long-term. This is because equities as an asset class are best equipped to ‘deliver’ results over the long-term. Over the short-term they can be extremely volatile and may even erode your retirement savings. There is little doubt that equity funds can help you achieve your investment goals. But for that to happen, you need to be invested for the long-term; at least 10 years in our view from a retirement planning perspective.

If you are saving for retirement by taking the equities route you will need advice; and we mean advice from experts and not tipsters, brokers, television channels or magazines for most of whom long-term means the next hour, next day or next week. When you have money in equities you need someone to constantly monitor the stock markets, the economy, interest rates and various domestic and global factors that are likely to have an impact on your investments. Given the enormity of the task it is easy to appreciate why managing equities is a full-time job. This is where mutual funds come in. Mutual funds usually have investment teams that seek investment opportunities in the stock markets on a full-time basis. This is something that as an investor you may attempt to do on your own, but may never have enough time or capability for given your personal and work commitments.

Having highlighted the benefits of long-term investing in equities, we would like to draw your attention to another critical aspect of retirement planning, i.e. asset allocation. Asset allocation is very important when you are deciding on your retirement portfolio. We have seen instances where stock market slumps have lasted for over 20 years. During that period, investors with above-average allocation to stocks witnessed significant erosion in their portfolios.

On the other hand, investors who had diversified their assets across avenues like bonds, gold, property and cash, managed to stay afloat and in some cases even clock reasonable returns. That is what asset allocation is all about; it allows investors to benefit from a well-diversified portfolio that helps them exploit opportunities and cut losses across ups and downs in the various asset markets.Despite the relatively smaller domestic mutual fund industry, you can be sure that selecting the best mutual fund schemes for retirement is a challenge.

There are several reasons for that - for one the industry has too many schemes within each category with little separating one from the other. And second , there are too many unscrupulous agents trying to milk their commissions out of unsuspecting investors by talking about the most irrelevant, but high commission paying, schemes. The irrelevance is even starker, when you consider the schemes from a retirement perspective.

So what is the best way to identify the mutual funds that must find their way to your portfolio? To be sure, there are ways to spot the right mutual funds; and the good news is that with a little bit of homework and some help from your qualified investment advisor you can be as good as anyone else at it.

1) Systems

Our advice to you - don’t get married to your fund manager. Instead pick an AMC based on its investment processes and systems and not its star fund manager. Process-driven AMCs adopt a team approach (as opposed to an individualistic approach), which tends to de-risk the exit of an individual leaving the team. When you are selecting a mutual fund make sure that it has well- defined investment processes that can function well even in the absence of a particular fund manager. We do not expect investors to have access to this information as easily as we make it out to be; that is where your investment advisor/mutual fund agent comes in. Ask him about the processes and systems adopted by various AMCs. If his advice is based on solid research and not commissions then he should be able to answer a lot of your questions on this topic.

2) Track Record

Once you have identified an AMC with well-defined investment processes, you should check its track record. Typically, equity fund performances must be monitored over at least three years in our view and from a retirement viewpoint, over 10 years. Some times you have a relatively new AMC like Fidelity Fund Management for instance, (with an established track record in other
markets) that can’t be gauged on the minimum 3-Yr track record. In such a scenario it makes sense to dig a little deeper and find out what its achieved in other markets, its systems and processes and what kind of experience they have in managing domestic stocks.

3) Go for funds with well-established track records; avoid NFOs

When you look at the domestic mutual fund landscape you see too many funds that have little relevance from a retirement planning viewpoint. A lot of them are thematic funds that, to begin with, do not have much of a track record. Moreover, when you are planning for retirement over a 20-30 year period, it is best to ignore themes and go for funds that invest across stocks and sectors without any bias. We believe that over the long -term , thematic fund performances are likely to be more erratic than consistent. There will come a time when the theme will have run its course leaving the fund manager with a truncated list of investment options. That is why it is best to invest in an equity fund that targets ‘capital appreciation’ - plain and simple, and not ‘capital appreciation through opportunities in outsourcing/capital goods/infrastructure/consumerism’. Remember if theses themes really merit investment then even the conventional equity fund manager is likely to invest in them. But the advantage he has is that he can exit the theme once it loses steam, unlike the thematic fund manager who has to remain invested in adherence to his investment mandate.

Another thing to avoid is NFOs, not that we have anything against them, but a lot of NFOs that are being launched presently are of the thematic fund variety. If there is an NFO of the ‘conventional’ variety, then we would recommend you evaluate it on the first two parameters.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

How To Invest in IPO Without Demat Account!

2008-01-23T20:39:00.000+05:30

FINANCE guru SPEAKS: To invest in an IPO, you need a demat account. Right?...Wrong! Here’s why. Even investors who don’t have a demat account are finding ways to bet on the Reliance Power mega issue. And there are brokers who are willing to show the way. As the deadline for the largest IPO draws near, several first-time retail investors who have missed the boom are desperate to get a slice of the cake.

According to market sources, the number of applications pending at various depositories have crossed 2 lakh since January. Though it normally takes two to seven days to open a demat account (provided the application forms are in place), the waiting period is getting longer due to a huge number of new applications in brokerages and a shortage of stamp papers.

Under these circumstances, street smart brokerages have devised a plan wherein fresh investors will be able to apply for an IPO without having a demat account at the time of sending the application money. The process is simple. An investor approaches a broker (who is also a depository participant) to open a demat account.

The broker, after collecting necessary documents like PAN, address-proof, photographs and a cheque (in the range of Rs 500 to Rs 850) as fee for opening a demat account, gives the person the DP ID instantly.

With the DP ID, the investor applies for the issue. However, the investor puts no ‘beneficiary account number’ on the form, or simply puts a random number. At the time of allotment, when the registrar spots a mismatch (or blank beneficiary account number column), the registrar is mandated to communicate the error (or omission) to the investor. By that time the investor would have received his real beneficiary account number; it then takes a simple correspondence between registrar and share applicant to insert the correct beneficiary account number, following which the shares will be transferred to the investor’s account.

“The arrangement allows investors to apply for the IPO, even though they are not in possession of a demat account. However, there are risks in the scheme. Due to a faulty beneficiary account number, there will be some delay in share allotment (the shares will probably be allotted after listing). So if you are an investor looking to cash in on the very first day, you may be disappointed,” said a Mumbai-based broker. A safer method to subscribe to the issue will be to take a demat account on “rent” from account-holders, who are not applying for the issue, say investment experts.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

How To Measure Risks Associated With Your Investments!

2008-01-19T19:47:00.000+05:30

FINANCE guru SPEAKS: Return, Risk, Liquidity and Tax Efficiency are the four factors that you would consider before making any investment. The problem is that three of these, namely Return, Liquidity and Tax Efficiency are measurable in terms of numbers. In other words, you know what the return of an investment has been in the past, how liquid is it and if any amount of tax can be saved if you invest. However, Risk is one factor, which is subjective, and you cannot immediately allocate a number to it.

And why is this important? Well, it is an understatement to say that the equity markets have become extremely volatile. Some time ago, the market was at an all time peak. And expected to go up further. And just when investors were thanking their lucky stars, the much-feared correction started taking place. Going ahead, would the sensex go up or will the correction continue? This is the future and no one has seen it. At best, people are taking educated guesses.

In other words, is the market too risky to enter at this stage or is the risk in line with the expected return? What are you as an investor to do in such a situation?

Well, the best thing to do is not to listen to others and take your own decisions after doing your homework.

So with the markets as they are poised, let us try and understand how to measure risk. Once you know this, then you don't have to depend upon others to predict the future - you can take a decision depending upon your risk profile.

Modern Portfolio Theory

'Modern Portfolio Theory' helps us in measuring risk. The first parameter to measure risk is known as the standard deviation. Don't worry about how to calculate it. These figures are given, you just have to know how to read and interpret them.

For any given expected rate of returns, (=mean of probability distribution) the investors would like to have a minimum deviation around the mean. This risk is the uncertainty of variability of returns, best measured by the standard deviation of expected returns about the mean.

If we assume that a particular security will return the average of say, its last 5 years, the standard deviation tells us the probability and extent to which the actual return would vary from the mean. In other words, it measures how risky is the investment by calculating, how much the actual return may deviate from the mean return.

What does Standard Deviation signify?

Standard deviation (SD) is probably used more than any other measure to quantify the risk of a security or that of a portfolio of securities. It is a scientifically proven fact that 67% of the population lies within the range 1s (the symbol for SD being s) around the mean, 95% lies within 2s and 99% within 3s. Therefore, once s of a portfolio is known, the investor has a very good idea of the risk of his earning a rate of return that differs from the expectation and the probability associated with it.

Standard Deviation quantifies risk by focusing attention on the time horizon. The expectation for a 1-year period is not necessarily the same for a 5-year period. This is the most welcome aspect since the investors do have different short, medium or long-term horizons. With this concept of risk and aversion to risk the investor should strive to build a portfolio that has the expected rate of returns with minimum expected deviations by diversifying his security selection, choosing either different kind of securities of different companies.

The long and the short of it is that the higher the standard deviation, higher is the risk and vice versa. So, next time you intend to buy an equity mutual fund scheme or a share, determine the SD from the broker or the agent. If he doesn't know, ask him to find out. Most of the websites and databases like Reuters and Bloomberg have these figures.

However, standard deviation, in a stand-alone mode has a severe drawback. It is an absolute measure and it suffers from not having a benchmark reference point. A low standard deviation may be attractive but not sufficient to make the investment decision. Common sense dictates that as an investor you need to know how your chosen security has performed vis a vis all the other securities, say the Sensex or the Sectoral Index.

For example, say the standard deviation of a scrip is extremely low. It tells you that the returns from the scrip are pretty steady. However, if the average return of that scrip is extremely poor as compared to its peer group, (this fact the standard deviation does not reveal) it may not make much financial sense to invest in that particular scrip.

Hence, in addition to standard deviation, this time we shall look at other commonly used measures - Beta and related measures, Alpha and Rho.

Beta

Beta captures systematic risk - risk common to the entire economic system - the market. Macro-economists call this business cycle risk. Unlike standard deviation, it measures the volatility of a security relative to a benchmark index. This tells the investor how volatile the returns on his scrip are as compared to the broad market index that he operates in. However, it is very important to select the appropriate benchmark.

To determine the beta of any security, you'll need to know the returns of the security and those of the benchmark index you are using for the same period. Using a graph, plot market returns on the X-axis and the returns for the stock over the same period on the Y-axis.

Upon plotting all of the monthly returns for the selected time period (usually one year), we draw a best-fit line that comes the closest to all of the points. This line is called the regression line.

Beta is the slope of this regression line. The steeper the slope, the more the systematic risk, the shallower the slope, the less exposed the company is to the market factor. In fact, the coefficient (Beta) quantifies the expected return for the stock, depending upon the actual return of the market.

Beta is fairly easy to interpret. It measures the sensitivity of the returns of a security to the market movements. The beta of the index is always 1. A beta that is greater than 1 means that the stock or the fund is more volatile than the benchmark index, while a beta of less than 1 means that the security is less volatile than the index. A negative beta indicates that the returns on the security move in an opposite direction to that of the index. For example, say the beta of a particular scrip is 1.08. We interpret the result as for every unit movement in the market index, our scrip moves by 1.08 units. In other words, our scrip is slightly more volatile than the broad market.

Stocks that rise and drop dramatically as compared to the market are those with high Betas. Typically Betas tend to be related to the industry. Technology, for instance, is a high-beta industry. On the other hand FMCG or pharmaceuticals is a low beta industry.

Alpha

Alpha is the point at which the regression line crosses the Y-axis. It represents the average return produced by the stock, independent of the market. Suppose Alpha is 1% and Beta is 1.5%. If the market's average return for a particular month was 2%, Beta will give you the value of expected return to be 3% (= 2% x Beta of 1.5%). To this we add Alpha and we get the most likely average return on the stock that month as 4%.

Rho

It is obvious that the relationship between the returns on the stock and the returns on the market are not perfectly consistent for each and every month. If they were, all the points would fall on the line of regression. But they do not.

Also, the efficency of Beta only comes into play when calculated against a relevant benchmark. For example if you measure the slope of returns on real estate against a bond index, you are sure to get an extremely low Beta. Does this mean real estate is a relatively safe investment? Definitely not. The only reason we get a low Beta is because the prices of the two sets of investments have not much correlation with each other.

So to reiterate, Beta is relevant only if the benchmark index is relevant. How do we know it is? Statisticians have developed a measure 'Rho', which is the correlation coefficient. It indicates the extent to which the individual observations deviate from this line of relationship. Rho lies between +1 and -1. A value of +1 would indicate perfect correlation, meaning thereby that our predictions are most accurate and when one parameter increases the other also increases and vice versa. Similarly, a value of -1 would also yield most accurate predictions but when one increases, the other decreases and vice versa. Correlation value of zero means no correlation whatsoever.

To Conclude

Use these tools do arrive at an educated decision before investing. Don't invest merely based on tips. Even if intend to act on a tip, take time to ascertain the values of the abovementioned parameters because they throw light upon how the scrip has moved historically. You will see, over time, your investment mistakes would have reduced considerably.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

What are Options!

2007-11-30T10:20:00.001+05:30

Know About Options

FINANCE guru SPEAKS: Before you begin options trading it is critical to have a clear idea of what you hope to accomplish. Only then will you be able to narrow down on an options trading strategy. Let us first understand the concept of options.An option is part of a class of securities called derivatives.The concept of options can be explained with this example.

For instance, when you are planning to buy some property you might have placed a nonrefundable deposit to hold it for a short time while you evaluate other options. That is an example of a type of option. Similarly, you have probably heard about Bollywood buying an option on a novel. In 'optioning the novel,' the director has bought the right to make the novel into a movie before a specified date. In both cases, with the house and the script, somebody put down some money for the right to buy a product at a specific price before a specific date. Buying a stock option is quite similar.

Options are contracts that give the holder the right to buy or sell a fixed amount of a certain stock at a specified price within a specified time. A put option gives the holder the right to sell the security, a call option gives the right to buy the security. However, this type of contract gives the holder the right, but not the obligation to trade stock at a specific price before a specific date.

Several individual investors find options useful tools because they can be used either as:

A) A type of leverage or

B) A type of insurance.

Trading in options lets you benefit from a change in the price of the share without having to pay the full price of the share. They provide you with limited control over the shares of a stock with substantially less capital than would be required to buy the shares outright. When used as insurance, options can partially protect you from the specific security's price fluctuations by granting you the right to buy or sell shares at a fixed price for a limited amount of time.

Options are inherently risky investment vehicles and are suitable only for experienced and knowledgeable investors who are prepared to closely monitor market conditions and are financially prepared to assume potentially substantial losses.

What are the different types of Options? How can Options be used as a strategic measure to make profits/reduce losses?

Options may be classified into the following types:

a) Call Option

b) Put Option

As mentioned before, there are two types of options, calls and puts. A call option gives the holder the right to buy the underlying stock at the strike price anytime before the expiration date. Generally Call options increase in value as the value of the underlying instrument increases.By contrast, the put option gives the holder the right to sell shares of the underlying stock at the strike price on or before the expiry date. The put option gains in value as the value of the underlying instrument decreases. A put option is one where one can insure a stock against subsequent price fall. If the value of your stocks goes down, you can exercise your put option and sell it at the price level decided upon earlier. If in case the stock price moves higher, all you lose is just the premium amount that was paid.Note that in newspaper and online quotes you will see calls abbreviated as C and puts abbreviated as P.

The examples stated below will explain the use of Put options clearly:

Case 1: Rahul purchases 1 lot of Infosys Technologies MAY 3000 Put and pays a premium of 250. This contract allows Rahul to sell 100 shares of Infosys at Rs 3000 per share at any time between the current date and the end of May.Inorder to avail this privilege, all Rajesh has to do is pay a premium of Rs 25,000 (Rs 250 a share for 100 shares).The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell.

Case 2: If you are of the opinion that a particular stock say "Ray Technologies" is currently overpriced in the month of February and hence expect that there will be price corrections in the future. However you don't want to take a chance , just in case the prices rise. So here your best option would be to take a Put option on the stock. Lets assume the quotes for the stock are as under:

Spot Rs 1040

May Put at 1050 Rs 10 May

Put at 1070 Rs 30

So you purchase 1000 "Ray Technologies" Put at strike price 1070 and Put price of Rs 30/-. You pay Rs 30,000/- as Put premium.

Your position in two different scenarios have been discussed below:

1. May Spot price of Ray Technologies = 1020

2. May Spot price of Ray Technologies = 1080

In the first situation you have the right to sell 1000 "Ray Technologies" shares at Rs 1,070/- the price of which is Rs 1020/-. By exercising the option you earn Rs (1070-1020) = Rs 50 per Put, which amounts to Rs 50,000/-. Your net income in this case is Rs (50000-30000) = Rs 20,000.

In the second price situation, the price is more in the spot market, so you will not sell at a lower price by exercising the Put. You will have to allow the Put option to expire unexercised. In the process you only lose the premium paid which is Rs 30,000.

What is Open Interest?

The total number of option contracts and/or futures contracts that are not closed or delivered on a particular day and hence remain to be exercised, expired or fulfilled through delivery is called open interest.

What are Index Futures?

As Stated above, Futures are derivatives where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. Index futures are futures contracts where the underlying is a stock Index (Nifty or Sensex) and helps a trader to take a view on the market as a whole.

What is meant by the terms Option Premium, Strike Price and Spot Price?

The price that a person pays for a call option/Put Option is called the Option Premium. It secures the right to buy/sell that particular stock at a specified price called the strike price. In other words the strike price is the specified price at which the holder of a stock option may purchase the stock. If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the option premium.

Premium of an option = Option's intrinsic value + Options time value

The stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by the option holder upon exercise of the option contract is called the Strike price. Spot Price is the current price at which a particular commodity can be bought or sold at a specified time and place.

What is meant by Settlement Price?

The last price paid for a contract on any trading day. Settlement prices are used to determine open trade equity, margin calls and invoice prices for deliveries.

How does one determine the price of an option?

A variety of factors determine the price of an option. The behavior of the underlying stock considerably affects the value of an option. Investors have different opinions about how a particular stock will behave in the future and hence may disagree about the value of any given option.In addition, the value of an option decreases as its expiration date approaches. Thus, its value is also highly dependent on the amount of time left before the option expires.

Intrinsic & Time Value

An options price is composed of its intrinsic value and time value.What a particular option contract is worth to a buyer or seller is measured by how likely it is to meet their expectations. In the language of options, that's determined by whether or not the option is, or is likely to be, in the money or out-of-the-money at expiration. Intrinsic value is how far an option is 'in-the-money.' Thus, the phrase is an adjective used to describe an option with an intrinsic value. A call option is in- the-money if the spot price is above the strike price. A put option is in the money if the spot price is below the strike price. It is calculated by subtracting the options strike price from the spot price. An out-of-the-money option has an intrinsic value of zero.

For example: if XYZ is trading at Rs 58 and the June 55 call is trading at Rs 4, to calculate the intrinsic value subtract Rs 55 from 58, leaving you with Rs 3 of intrinsic value. The remaining Rs 1 is known as extrinsic or time value. Time value is the amount over intrinsic value that a buyer pays for the option. While buying time value, an options purchaser assumes that the option will increase in value before it expires. As the option nears expiration, its time value starts decreasing toward zero.

Theoretical Value

Theoretical value is the objective value of an option. It shows how much time-value is left in an option. The most commonly used formula to calculate the theoretical value of an option is known as the Black-Scholes model.This model considers the price of the stock, the options strike price, the time remaining before expiration, the volatility of the underlying stock, the stock's dividends and the current interest rate while arriving at the theoretical value of the option.

Although an option may trade for more or less than its theoretical value, the market views the theoretical value as the objective standard of an option's value. This makes the price of all options tilt toward their theoretical value over time.

The Components of Theoretical Value:

Volatility

The volatility of the underlying stock is one of the key factors in determining the value of an option. Often, the options price increases as the volatility of the stock increases. The difficulty in predicting the behavior of a volatile stock permits the option seller to command a higher price for the additional risk. There are two types of volatility, historical and implied. As the term suggests, historical volatility is a measurement of the stocks movement based on its past behavior.By contrast, implied volatility is calculated using option prices. It is a measurement of the stocks movement as implied by how the market is currently valuing options.

Dividends

As an owner of a call option you can always exercise your right to the stock and receive any dividend it might pay.

Interest Rate

If you buy an option rather than a stock, you invest less money upfront.

Days Until Expiration

An option, being a wasted asset; wastes a little as each day lapses. Thus its value is calculated in accordance to the amount of days left in its life.

What are Swaptions?

A swaption is an option on an interest rate swap. Swaptions are options contracts, which give you the right to enter into a swap agreement at the option expiration, in return for a one-off premium payment.

What is meant by Covered Call, Covered Put, In the Money, Out Of the Money, At the Money?؉

In-the-money

A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.

؉Out of the money

A call option is out-of-the-money if the price of the underlying instrument is lower than the exercise/strike price. A put option is out-of-the-money if the price of the underlying instrument is above the exercise/strike price.؉

At-the-money

At the money is a condition in which the strike price of an option is equal to (or nearly equal to) the market price of the underlying security.

؉Covered Call

You can take a covered call if you take a long position in an asset combined with a short position in a call option on the same underlying asset.؉

Covered Put

The selling of a put option while being short for an equivalent amount in the underlying security.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

What are Futures!

2007-10-30T15:22:00.000+05:30

Know About Futures

What are Derivatives?

A derivative is a financial instrument whose value depends on the values of other underlying variables. As the name suggests it derives its value from an underlying asset. For Example-a derivative, may be created for a share, or any material object. The most common underlying assets include stocks, bonds, commodities etc.

Let us try and understand a Derivatives contract with an example:

Sunil buys a futures contract in the scrip "TCS". He will make a profit of Rs.500 if the price of TCS rises by Rs 500. If the price remains unchanged Anil will receive nothing. If the stock price of TCS falls by Rs 800 he will lose Rs 800.

As we can see, the above contract depends upon the price of the TCS scrip, which is the underlying security. Similarly, futures trading can be done on the indices also. Nifty futures is a very commonly traded derivatives contract in the stock markets. The underlying security in the case of a Nifty Futures contract would be the Index-Nifty.

What are the different types of Derivatives?

Derivatives are basically classified into the following:

a) Futures /Forwards

b) Options

c) Swaps

What are Futures?

A futures contract is a type of derivative instrument, or financial contract where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price.

The example stated below will simplify the concept:

Case1:

Ravi wants to buy a Laptop, which costs Rs 50,000 but owing to cash shortage at the moment, he decides to buy it at a later period say 2 months from today.However,he feels that after 2 months the prices of Lap tops may increase due to increase in input/Manufacturing costs .To be on the safer side, Ravi enters into a contract with the Laptop Manufacturer stating that 2 months from now he will buy the Laptop for Rs 50,000. In other words he is being cautious and agrees to buy the Laptop at today's price 2 months from now.The forward contract thus entered into will be settled at maturity. The manufacturer will deliver the asset to Ravi at the end of two months and Ravi in turn will pay cash delivery.

Thus a forward contract is the simplest mode of a derivative transaction. It is an agreement to buy or sell a specific quantity of an asset at a certain future time for a specified price. No cash is exchanged when the contract is entered into.

What are Index Futures?

As Stated above, Futures are derivatives where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. Index futures are futures contracts where the underlying is a stock index (Nifty or Sensex) and helps a trader to take a view on the market as a whole.

What is meant by Lot size?

Lot size refers to the quantity in which an investor in the markets can trade in a derivative of a particular scrip.For Example-Nifty Futures have a lot size of 100 or multiples of 100.Hence if a person were to buy 1 lot of Nifty Futures , the value would be 100*Nifty Index Value at that point of time.

Similarly lots of other scrips such as Infosys, reliance etc can be bought and each may have a different lot size. NSE has fixed the minimum value as two lakhs for an Futures and Options contract. Lot sizes are fixed accordingly which will be the minimum shares on which a trader can hold positions.

What is meant by expiry period in Futures?

Each contract entered into has an expiry period. This refers to the period within which the futures contract must be fulfilled. Futures contracts may have durations of 1 month,2 months or at the most 3 months. Each contract expires on the last Thursday of the expiry month and simultaneously a new contract is introduced for trading after expiry of a contract.

What are the uses of Derivatives? What are the various derivative strategies that I can use?

Derivatives have a multitude of uses namely:

a) Hedging

b) Speculation

c) Arbitrage

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

What are Arbitrage Funds!

2007-10-29T10:40:00.000+05:30

What are Arbitrage Funds

FINANCE guru SPEAKS: Investing money for short-term, say up to 1-2 years has generally been an issue. As it is the interest rates / returns are quite low. On top of this, there could be taxation issues, which will further reduce the effective returns.
Equity/equity funds may not be a prudent option for short-term. Therefore, we need to consider mainly the interest-based investment options.

What Do We Usually Do?

Since it is quite convenient, very often the money keeps lying in the Savings A/c itself (also, maybe it is psychologically satisfying to see a big balance in one's account). But don't forget - this earns you just 3.5% p.a. interest and that too taxable. Hence, it is not good to keep too much money in the Savings A/c.

The next common thing to do is to make a FD. This may earn you 6-9% interest depending on the tenure. But this too is taxable (if you are in the highest tax bracket, even a 9% FD will fetch you just 6.3% post-tax returns). So, given the fact that there are better alternatives, this too may not be a very intelligent choice.

What are the Alternatives?

Certain debt MFs offer an attractive alternative to Bank FDs. In case you are sure about your investment horizon, you can opt to invest in Fixed Maturity Plans. Else, if you want quick liquidity, liquid plus/floating rate funds could be considered.

The pre-tax returns from these funds will be more or less in line with the returns from the Bank FDs. However, it is the difference in tax treatment on interest from bank FDs and returns from MFs, which enables MFs to give much better post-tax returns.

Interest from Bank FDs is fully taxable as per one's slab rate. As against this, returns from Debt MFs will be taxed as either Dividend (@14.1625%) or Capital Gains (Long Term @11.33% and Short Term as per one's slab rate).

Let's assume that both FD and MFs give 8% returns. Then if you are in the 30% tax bracket, your post-tax return from Bank FD will be 5.60%. But, if you invest in MFs, you will earn either 7.01% (dividend if period is less than 1 year) or 7.09% (LTCG if period is more than 1 year).

Besides this, there is lot of convenience with MFs. MFs will deduct this Dividend Distribution Tax and pay you the net amount. You don't have to do anything. But in case of interest earning you will have to show it in your returns and pay tax, including advance tax. Also banks will deduct TDS on interest income. So at the year-end you will also have to get the TDS certificate from them.

How Arbitrage Funds Fit In?

Before we see how arbitrage funds can be useful, let's first understand the concept of such funds.
Though, arbitrage funds invest in equity and derivatives such as futures & options, they are essentially debt funds. This is because when they invest in equity, they also take an exactly opposite position in futures. The objective is to capitalize on the difference in the prices in the cash market and the futures market (and hence the term arbitrage) rather than making money on equity or derivatives.

For example, say they buy Infosys shares @ Rs.1800/share in cash market on Aug 1. At the same time, they will sell Infosys shares in the futures market, which would be quoting for say about Rs.1815 (the difference in financial parlance is called the cost of carry).

Let's say the price of Infosys on the expiry date of the futures contract (last Thursday of the month) is Rs.1900. Thus, the fund will make a profit of Rs.100 in the cash market [Rs.1900 - Rs.1800] and loss of Rs.85 [Rs.1815 - Rs.1900] in the futures market. (On the expiry date the cash and future prices are same). The net gain is Rs.15.

Or suppose the price of Infosys drops to Rs.1700. Thus, the fund will make a loss of Rs.100 in the cash market [Rs.1700 - Rs.1800] and profit of Rs.115 [Rs.1815 - Rs.1700] in the futures market. Again, the net gain is Rs.15

This way, the market movement does not affect them. They earn Rs.15, whatever may be the final price, which in this case works out to about 10% p.a. assured returns (@Rs.15 on Rs.1800 in one month).

In nutshell, arbitrage funds will yield returns more or less in line with liquid funds / floating rate funds or FMPs; and, more importantly, with practically very little risk.

For example, in last 6-12 months arbitrage funds have given about 9.25% p.a. average returns, while floating rate funds have given around 7.5% returns, liquid plus funds around 7.9% returns and FMPs around 8.5% returns.

Now, the key point for tax purposes arbitrage funds are treated as equity funds.

Thus they could give even better post-tax returns than debt MFs.
If the period is less than 1 year, both Debt Funds and Arbitrage Funds will give almost the same returns. At 8% pre-tax returns, the post-tax return works out to about 7%. But, if the period were 1 year, then post-tax yield would be 7.09% in debt funds and 7.73% in arbitrage funds.

Are Arbitrage Funds OK to Invest in?

There are no major risks associated with arbitrage funds unlike market-risk in equity funds or interest-rate risk in normal debt funds.
However, there could some minor risks. There may not be any arbitrage opportunities available, especially in bearish markets. In such cases, the arbitrage funds will work like liquid funds. Or on the expiry, the rates in cash and futures markets may not match exactly. This could marginally affect the returns. Or there could be some problems in executing the deals due to low liquidity.

Apart from this, one must keep certain points in mind:

* Arbitrage funds usually have an exit load for investment period less than 3 months. So make sure that you won't need this money for at least 3 months.

* The returns are linked to expiry of contracts (which happens on the last Thursday of the month). So you need to be a bit careful about your redemption dates.

Concluding, therefore, one can say that arbitrage funds can be a good alternative to invest our short-term money, where we can earn high post-tax returns with reasonable degree of safety and surety.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

How To Invest Abroad!

2007-10-25T16:26:00.000+05:30

How To Invest Abroad

FINANCE guru SPEAKS: When the Tatas were fighting the Brazilian CSN for buying the UK steel giant Corus, in a remote corner of Punjab, Ankit Bagga knew that no matter who eventually took over the company, buying shares of Corus would not be a wrong move. And, in a few easy steps, that's exactly what he did. He remitted money from his bank account in India to his broker in London and bought 850 shares of Corus at 663 pence a share at the London Stock Exchange (LSE). The next morning, he sold them all at 706 pence a share and netted an overnight profit of over six per cent. Not bad for less than a day's work, or, more specifically, for a few double-clicks on his computer.

With the Reserve Bank of India (RBI) easing the norms for Indians investing abroad, Bagga is a part of a growing tribe of people making money through offshore transactions. Resident Indians were first permitted to invest abroad in 2004, when a Budget announcement allowed remittances of up to $25,000 a calendar year. However, regulatory clearances came through only last year. Now, there is clarity on how you can go about buying shares of Coca-Cola or arbitraging in the pound sterling. In April this year, the RBI raised the amount individual Indians can remit abroad every financial year for any permitted current or capital account transaction to $1,00,000.

This has thrown open many asset categories to investment. You can buy equity directly at any foreign stock market, or buy mutual funds, insurance policies, commodities, foreign currency and even real estate. The advantage of making these investments, especially for high net worth individuals, is that they can cover geographical and currency risks. If you feel that an impending eventuality, such as an election, is making the Indian market volatile, then you can avoid the risk that comes with investing in it by putting your money in the Nasdaq or LSE or Hong Kong Stock Exchange. Similarly, you can invest in the Euro or the pound sterling or the dollar if the rupee is threatened by global or macroeconomic factors. However, you need to be very aware of these markets and track them carefully if you invest in them.

Mumbai-based Kanti Shah started trading on the London Metal Exchange (LME) as he was familiar with the market and it offered an easy way of diversifying his portfolio. Kanti Shah and his wife Bhavna have been running a silver jewellery store in Mumbai for the last seven years. "I first tried hedging on silver through the platform provided by the Multi-commodity Exchange of India, but that was very difficult and I could not understand that," says Kanti. "Then, Reliance Money brought me access to the LME through a platform called CMC, a London-based company. It was really easy to understand and use and that's how I started hedging on silver in the international market. I can see the price movement on a second-by-second basis."

Shah uses his understanding and experience of the domestic silver market to invest in the metal internationally. He pays 1 per cent margin and hedges on the price.

How Do You Begin?

Procedurally, it is rather easy for you to get started. All you need is a bank account with a branch that allows foreign remittances and an account with a provider like Reliance Money or Man Financial, or a large bank which provides options for global investments.Indian service providers have tie-ups with international equity, commodity and currency brokers, who allow you to use their platform for trading. You remit the money to your account with them by filling up Form A2 and the money is wire transferred in a day or two. Once it's there, you can use it to invest in stocks, commodities, indices, derivatives or currency. Popular areas of investment currently are equity, indices, currency and commodity derivatives. When you want to sell and book your profits or losses, all it takes is double clicking on that option in the platform. You can then choose to have your money transferred back electronically to your bank account.

Who Should Invest in Offshore Products?

The easy answer is: high net worth individuals and people who have an investible surplus after putting money in insurance, mutual funds, real estate and equity in India. They can then look at global products and derisk their investments from geographical and currency concerns. However, these products and markets should be understood in depth before funds are committed. Studies and news on global markets and products are not easily available and one should look at these investments only if one has the time and interest to analyse and understand them.

The other group of investors for whom offshore investments are ideal are those who have specific commodity or equity interests. Like Shah, who has taken a step forward from his silver jewellery business by investing in silver at the LME. Employees, especially highly-paid IT employees, can look at investing in their parent companies and add to their kitty of stock options.You don't necessarily have to be rich to trade overseas though. You can start off by investing small sums of money and then make bigger buys. Bagga started off with a $500 investment.

Where You Can Come Unstuck.

Even though the number of Indians investing abroad has shot up in the recent past, several procedural grey areas remain. Taxation methods and systems vary from country to country and you should check whether you are liable to pay taxes in your country of investment. The procedure for remitting money is not very smooth, says Sudip Bandyopadhyay, CEO, Reliance Money. "For one, banks have know your customer (KYC) norms and may not allow you to remit money as soon as you open an account," he says. "You should have an existing relationship with them. Also, procedures vary from branch to branch. A bank employee in a remote branch will not know how to go about helping you remit."

Real estate investments are especially vulnerable to scams. Says the head of a leading global real estate company, "A lot of investments made by Indians in the UK are on land in 'no development zones'. So, you may buy a piece of the English countryside and then realise too late that you do not have the necessary permissions to build your dream mansion on it. You can at best stroll in your meadow."

Adding to the confusion of remittances is the fact that the RBI has now disallowed transactions that are in the nature of remittances for margins or margin calls to overseas exchanges or overseas counter-parties. Since most service providers offer exciting margins on transactions, this could take the sheen off the investments a little.If the stories of multi-million dollar lottery winners have been inspiring you, there is bad news. The RBI's scheme cannot be used for purchasing lotteries, sweepstakes or tickets proscribed by international magazines. You also cannot make remittances to Bhutan, Nepal, Mauritius or Pakistan under this scheme. As far as the issue of filing of tax statements in India is concerned, the statements from your broker and bank are sufficient.

All said, it is a big world out there and it is time we tapped it. While risks are inherent, Bagga says he is more comfortable with the way global markets are run. "These markets deal in trillions of dollars, and no one individual or group of funds can manipulate them. If I move with the trend, I will only benefit from investing abroad," he says. The world is now our oyster, and the pearl hunt has begun. Indeed!

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

What are Participatory Notes!

2007-10-24T15:50:00.000+05:30

Why Participatory Notes are Dangerous

FINANCE guru SPEAKS: Participatory Notes (PN) — a general name used for the investment by Foreign Institutional Investors (FIIs) through Offshore Derivative Instruments (ODIs) such as Participatory Notes, Equity-Linked Notes, Capped Return Notes and Participating Return Notes — have created a storm in the stock market, with SEBI coming out with a draft for discussion to regulate them, the RBI suggesting that they be phased out, and the Finance Minister assuring that the Government is not going to phase them out.

First things first. Let us clearly understand the fundamental issues. The PNs are a slap on the face of every citizen who is an investor. For a person to invest even in one share, several KYC (know your customer) forms have to be filled up, and PAN numbers and proof of address, etc., provided. For the PN investor the system is totally silent on even elementary information. The FIIs issue PNs to funds/companies whose identity is not known to the Indian authorities.

Hence, the PN system is blatantly discriminatory and seems to favour ghost investors. Any self-respecting market, if it discriminates at all, does so against outsiders. But we have done the unthinkable.
We should recognise and internalise the fact that funds are in search of markets, and not the other way. Given the demographic shift in the developed markets (where pension funds have to locate markets to get returns for longer periods) and the lack of huge opportunities in long-term projects, it is natural that global funds are in search of markets.

The PN route, through which a section of investors is participating in our markets, is a mystery wrapped in a puzzle, crammed inside a conundrum and delivered through a riddle. These are address-less funds that could be from dubious sources and the clamour for it is intriguing, if not outright suspicious.

Current Scenario

According to the SEBI Web site, the current position of these instruments is as follows: “Currently, 34 FIIs / Sub-accounts issue ODIs. This number was 14 in March 2004. The notional value of PNs outstanding, which was at Rs 31, 875 crore (20 per cent of Assets Under Custody of all FIIs/Sub-Accounts) in March 2004, increased to Rs 3,53,484 crore (51.6 per cent of AUC) by August 2007.

The value of outstanding ODIs, with underlying as derivatives, currently stands at Rs 1,17,071 crores, which is approximately 30 per cent of total PNs outstanding. The notional value of outstanding PNs, excluding derivatives as underlying as a percentage of AUC is 34.5 per cent at the end of August 2007.” (SEBI – Paper for Discussion on ODIs).

This implies that more than 50 per cent of the funds are flowing through this anonymous route which needs a re-think on this entire issue. This brings us to the question about who are the investors interested in Indian Papers.

Who Uses The PN Route

The first category is the regular funds whose twin objectives are returns and more returns on a 21*7*365 basis. They are interested in India since the India story is very good and returns are attractive compared to developed markets. The second category is prodigal money returning. It is not a secret that a large number of politicians/bureaucrats/business-persons have accumulated wealth abroad. This has been accumulated by under-invoicing/over-invoicing, by corruption in contracts and gifts from abroad; and by not bringing in legitimate receipts.

The third category is those foreign governments/entities who would like to acquire/control Indian entities by taking them over.
The fourth category is the terror financiers who could find this route attractive and simple. The first category does not have any reason to use the “anonymous” route since the aim is to earn returns /repatriate and benefit out of interest rate and currency value arbitrage. They enter and exit as per these calculations and are not shy about the greed for maximum returns. They pay the taxes applicable and laugh all the way to the bank with bonus incentives.

The only issue is that currently the stock market is the only route for investing while several other “unlisted” sectors, such as trade, transport, restaurants and other services are starved of funds. Maybe methods should be evolved to get these regular global funds to invest not just in the top ten shares of the stock market but in the needs of the large non-corporate or “ unlisted” segments of the economy, through NBFCs. That would ease the volatility in the market since currently large funds are chasing too few shares of the Sensex or Nifty.

No More Safe Heavens

The second category will be enthusiastic in bringing the money back into India since the KYC (Know your Customer) norms in many so-called “safe” territories like Switzerland are becoming tougher — particularly after 9/11— and the India story is very interesting and the returns and growth prospects are very good. The Government can always think of an “Amnesty Scheme” for such “prodigal funds” in the form of “no questions asked” about the source. But, once the funds are brought in, then all the KYC norms must be followed, with minimum legal and tax hassles. After all, such amnesty schemes for the domestic black-money holders in the past have met with reasonable success. Otherwise, a Special Purpose Vehicle (SPV) can be created which can be dollar-denominated to hold these funds at attractive rates and which are converted over a period of time to minimise the flow impact.

Harmful For Companies

The third category spells danger for domestic companies since the unknown entity may be targeting the local company without its knowledge. With reasonable control they can pressure the current owners to settle with them or even try taking over.
This becomes more ominous in the context of several sovereign funds, like that of China, using the private equity companies to manage their funds which are non-transparent.

These PEs could use other vehicles to acquire on behalf of these sovereign funds and it may be possible that Chinese or West Asian sovereign funds may hold indirectly shares in Indian companies, particularly in software or oil or telecom, which are critical sectors.
The fourth category is the one to be worried about. The terror financier will be happy on two counts, namely the anonymity provided by these instruments and the domestic regulations on gifting the shares.

Also important is the issue of the sale of these PNs to entities that could be inter-connected to the original buyers.
In other words, the original buyer and to whom he sells could belong to inter-connected terror entitities, in which case the global entity could have succeeded in transferring funds to India with ease and anonymity.

It is not without basis that the National Security Advisor (NSA) has cautioned against terror-financing through the banking and stock market channels.
That is a cause for concern. Why are we insisting on the anonymity of the investor and the sources? Why not have confidence in the India story and realise that we can get funds with addresses since we have arrived on the global arena?

We should distinguish between clean global flows and dubious flows as a responsible country with a remarkable growth story.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

More Health Cover Options for Senior Citizens!

2007-10-22T15:14:00.000+05:30

Health Cover Options for Senior Citizens

FINANCE guru SPEAKS: Senior citizens may soon have more choices to pick for their health insurance cover. Oriental Insurance has filed a specific health insurance product for senior citizens with the insurance regulator (IRDA). Oriental is the third public sector general insurance company to look at such a product after National and New India Assurance. While National Insurance launched its product last year, New India launched its product in October this year.

It is expected that IRDA, the regulatory body for the insurance business, will approve the Oriental product shortly. Speaking on the sidelines of a seminar, chairman and managing director, M Ramadoss, said that the product would have a maximum sum assured of Rs 2 lakh. Ramadoss also added that the product would cover a longer list of specific diseases. ‘‘The product will be a co-payment cashless product (where the insured person shares a proportion of the claim).

The entry age would be 60 while the coverage will be available till the age of 85,” said Ramadoss. Although, Ramadoss did not divulge exact details, he said the plan would cover pre-existing diseases after a period 2-3 years. New India’s new product offers a maximum sum assured of Rs 1.5 lakh and the entry age of 60 years with the cover available till the age of 80. New India’s policy for senior citizens covers pre-existing diseases after 18 months. The premium for the age bracket of 60-65 years for Rs 1 lakh is Rs 3,850.

Ramadoss also added that given the huge loss ratios arising of group health policies, the company had refused to write business of Rs 70 crore this year. ‘‘It was the business that we had written last year. This year, however, we refused to write it becuase of the inappropriate pricing,’’ he added. Ramadoss said that he expected the premium growth of the company to be around 5% by the financial year end. Until now, however, growth has been more or less flat. Other general insurance companies also expect profitability to be affected post detariffing. After the launch of their revamped mediclaim product last year, Oriental has seen a drop in the premium growth rate. During Last financial year, there had been a 40% growth in premiums in health insurance.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

Journey Of Sensex!

2007-10-10T11:40:00.000+05:30

Journey Of Sensex

FINANCE guru SPEAKS: Indian markets achieved yet another milestone on Tuesday. The Sensex crossed the 18,000-mark on the back of renewed buying today. The index hit a fresh all-time intra-day high of 18,327. It took just 8 trading days to hit 18,000 from the 17,000 mark. The last 2,000 points have come in a short span of just 13 trading sessions.

Following is the timeline on the rise and rise of the Sensex through Indian stock market history.

1000, July 25, 1990

On July 25, 1990, the Sensex touched the magical four-digit figure for the first time and closed at 1,001 in the wake of a good monsoon and excellent corporate results.

2000, January 15, 1992

On January 15, 1992, the Sensex crossed the 2,000-mark and closed at 2,020 followed by the liberal economic policy initiatives undertaken by the then finance minister and current Prime Minister Dr Manmohan Singh.

3000, February 29, 1992

On February 29, 1992, the Sensex surged past the 3000 mark in the wake of the market-friendly Budget announced by the then Finance Minister, Dr Manmohan Singh.

4000, March 30, 1992

On March 30, 1992, the Sensex crossed the 4,000-mark and closed at 4,091 on the expectations of a liberal export-import policy. It was then that the Harshad Mehta scam hit the markets and Sensex witnessed unabated selling.

5000, October 8, 1999

On October 8, 1999, the Sensex crossed the 5,000-mark as the BJP-led coalition won the majority in the 13th Lok Sabha election.

6000, February 11, 2000

On February 11, 2000, the infotech boom helped the Sensex to cross the 6,000-mark and hit and all time high of 6,006.

7000, June 20, 2005

On June 20, 2005, the news of the settlement between the Ambani brothers boosted investor sentiments and the scrips of RIL, Reliance Energy, Reliance Capital and IPCL made huge gains. This helped the Sensex crossed 7,000 points for the first time.

8000, September 8, 2005

On September 8, 2005, the Bombay Stock Exchange's benchmark 30-share index -- the Sensex -- crossed the 8000 level following brisk buying by foreign and domestic funds in early trading.

9000, November 28, 2005

The Sensex on November 28, 2005 crossed the magical figure of 9000 to touch 9000.32 points during mid-session at the Bombay Stock Exchange on the back of frantic buying spree by foreign institutional investors and well supported by local operators as well as retail investors.

10,000, February 6, 2006

The Sensex on February 6, 2006 touched 10,003 points during mid-session. The Sensex finally closed above the 10K-mark on February 7, 2006.

11,000, March 21, 2006

The Sensex on March 21, 2006 crossed the magical figure of 11,000 and touched a life-time peak of 11,001 points during mid-session at the Bombay Stock Exchange for the first time. However, it was on March 27, 2006 that the Sensex first closed at over 11,000 points.

12,000, April 20, 2006

The Sensex on April 20, 2006 crossed the 12,000-mark and closed at a peak of 12,040 points for the first time.

13,000, October 30, 2006

The Sensex on October 30, 2006 crossed the magical figure of 13,000 and closed at 13,024.26 points, up 117.45 points or 0.9%. It took 135 days for the Sensex to move from 12,000 to 13,000 and 123 days to move from 12,500 to 13,000.

14,000, December 5, 2006

The Sensex on December 5, 2006 crossed the 14,000-mark to touch 14,028 points. It took 36 days for the Sensex to move from 13,000 to the 14,000 mark.

15,000, July 6, 2007

The Sensex on July 6, 2007 crossed the magical figure of 15,000 to touch 15,005 points in afternoon trade. It took seven months for the Sensex to move from 14,000 to 15,000 points.

16,000, September 19, 2007

The Sensex scaled yet another milestone during early morning trade on September 19, 2007. Within minutes after trading began, the Sensex crossed 16,000, rising by 450 points from the previous close. The 30-share Bombay Stock Exchange's sensitive index took 53 days to reach 16,000 from 15,000. Nifty also touched a new high at 4659, up 113 points. The Sensex finally ended with its biggest-ever single day gain of 654 points at 16,323. The NSE Nifty gained 186 points to close at 4,732.

17,000, September 26, 2007

The Sensex scaled yet another height during early morning trade on September 26, 2007. Within minutes after trading began, the Sensex crossed the 17,000-mark . Some profit taking towards the end, saw the index slip into red to 16,887 - down 187 points from the day's high. The Sensex ended with a gain of 22 points at 16,921.

18,000, October 09, 2007

The BSE Sensex crossed the 18,000-mark on October 09, 2007. It took just 8 days to cross 18,000 points from the 17,000 mark. The index zoomed to a new all-time intra-day high of 18,327. It finally gained 789 points to close at an all-time high of 18,280. The market set several new records including the biggest single day gain of 789 points at close, as well as the largest intra-day gains of 993 points in absolute term backed by frenzied buying after the news of the UPA and Left meeting on October 22 put an end to the worries of an impending election.

For More Learning, Please Visit "AT A GLANCE" Section on the Right Hand Side.

Know About Floating Car Loans!

2007-10-09T17:47:00.000+05:30

Floating Car Loans: Good or Bad?

FINANCE guru SPEAKS: ICICI Bank recently announced the introduction of floating rate car loan -- a first among the banks that are very active in car loans. Floating rate option till now was available only for the longer tenure home loans. But is it a viable option for the short tenure -- 3 to 5 years -- car loans?

First, let us look at the interest rate differential available between the floating rate and fixed rate car loan offered by ICICI Bank. The differential is only 50 basis points (100 basis points make 1 per cent). That is, if you can get a fixed rate car loan from ICICI Bank for 14 per cent, then if you are opting for a floating rate, you could get the loan for 13.5 per cent.

Your outgo for the fixed rate loan will remain the same for the entire loan tenure -- whether the interest rate move up to 16 per cent or it moves down to 12 per cent. On the other hand -- at least technically in a floating rate option -- your outgo will reduce if the interest rate moves down or your outgo increases if the interest rate moves up.
In such a scenario, the straight forward answer is to choose your loan type depending on your risk taking capacity and your outlook on interest rate movement for the next few years.

* If you do not want to take any risk and wants to freeze your outgo, go for a fixed rate car loan.

* If you are willing to take risk, but you think interest rate is going to rise, again the best option for you is fixed rate loan. This way you would have locked yourself at a lower interest rate than your anticipated future higher interest rate.
If you believe that interest rate will move down in the next few years, the ideal option would be to take a floating rate car loan. This way interest rate on your car loan also will move down, at least theoretically.

These are ideal scenarios, but in real life, things work out a little differently. Is there a guarantee that banks will reduce interest rate on your floating rate car loan if the general interest rate starts moving down? Sadly, there is no such guarantee. There is no past experience to rely on for car loans. But we have some experience with floating rate home loans.
Since interest rates have been consistently moving upwards for the last 3-4 years, there is no immediate past data for us to check about banks behavior when general interest rate moved down. The most immediate past where interest rate consistently moved down for long duration was during 2001 to 2003 period.

During that period, almost all banks were slower in decreasing interest rate for their existing floating rate loan consumers compared to the briskness with which they have increased interest rates on existing floating rate loans during 2004 to 2007 period.

A floating rate loan has three components:

(1) Effective rate (the actual interest rate applicable to a loan. Lets assume it is 14 per cent),

(2) Benchmark rate (this is only a reference or benchmark rate, which is normally a little lower or higher than the actual rate. Lets assume this is 12 per cent) and

(3) mark up or mark down (This is the difference between the benchmark rate and the actual rate. In our instance, it is 14-12=2 per cent or the effective rate is benchmark rate plus the mark up of 2 per cent).

Banks change the effective rate by changing the bench mark rate or mark up rate. If the bank drop benchmark rate by 1 per cent, automatically, your effective interest rate goes down by 1 per cent, i.e 11 (benchmark rate) +2 per cent(mark up) =13 per cent.

Similarly the bank can also effect a drop in interest rate by changing only the mark up rate to 1per cent and by keeping the benchmark rate same. In such cases, the effective interest rate becomes 12 per cent+1 per cent=13 per cent. Very often the rate drops are effected through change in the markup rates only while the benchmark rate remains the same. What this means is that only the new consumers get the benefit of the reduced rates since existing consumers are already locked into their markup rates.

Recently quite a few banks have announced 50 basis point rate reduction in their home loan rates after a gap of many years. This has been done through reduction in the markup rate by all the banks. Since it is a change on the mark-up it will not have an effect on existing loans. Had the banks made a rate reduction by cutting the benchmark rate, existing borrowers too would have had their interest rate reduced.
The other factor is prepayment charge. In the case of home loans this tends to be around 2 per cent of the amount pre-paid. So if the interest rates have dropped a lot and the bank has withheld giving you the benefit by changing only the mark up you can always threaten to shift your home loan and force the bank to pass on the benefit to you as well. In the case of car loans the prepayment charge is as high as 5 per cent. Hence you are more or less locked in to your existing lender.

So before you jump for the floating rate car loan, please pause for a minute. Given the fact that the differential between the fixed rate and floating rate is only 50 basis points and that the prepayment charges are so high and the chances of your benefiting from any general decrease in rates (but you continue to run the risk of paying more if the general interest rates increase) it might make better sense to stick to fixed rate car loan.

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Sensex and Rupee on its All Time High!

2007-09-28T21:56:00.000+05:30

Impact Of Sensex & Rupee Rise

FINANCE guru SPEAKS: The rupee is at its highest level against the US dollar in nine years. Mukesh Ambani-controlled Reliance companies' market cap now exceeds $100 billion (as also Arcelor Mittal's). The new generation winners operate in a myriad and highly diverse sectors including telecom, commodities such as steel and cement, conventional and non-conventional energy, financial services, and transportation.

Yet, ironically, the poster boy of Indian entrepreneurship -- the Indian software industry -- has now joined the ranks of more traditional whiners such as the textile and clothing sector for further government support and subsidies to bail them out of the impact of a strengthening local currency. This is not withstanding the long history of government largesse doled out to the exporting community by way of land and other infrastructure at concessional rates, foregone taxes and refunds of duties collected (or at times, such as in the case of the textile sector in the previous years, not even actually collected).

How do some companies acquire and then continue to create and accumulate unprecedented value while others seem to plateau out, stagnate, or even begin to fritter away an otherwise promising position? How have some Indian companies developed the DNA to think and act global (in terms of ambition, scale, best practices, wealth creation) while others have apparently reconciled to be just another player in their chosen sector (s)?
In my view, today's winners have a better instinctive understanding of value drivers of modern business while stragglers and the have-beens are still rooted to what were the value drivers in another era.

Which are the contemporary value drivers? To start with, having a global mindset and a desire to be the world's best is a must. This does not necessarily imply a dream to be the largest in terms of revenue, profits, assets, or market share. It is simply the desire to excel and continuously benchmark with the best of the breed and then strive to better those benchmarks. BMW, Ikea, and even India's own Kingfisher Airlines are among a diverse group that are not the world's largest in their respective industries but have continuously set benchmarks for others and are doing so.

An ability to look at the big picture first and then get down to more mundane details are the second hallmark of today's winners. Companies like Reliance Industries have first built the infrastructure needed for them to implement their gigantic business plans. This could include physical infrastructure such as ports, roads, power plants, and desalination plants; technological infrastructure (national, regional, and intra-office connectivity), and human resource infrastructure (inducting global and local talent in vast numbers, training and retraining the thousands and tens of thousands of skilled and semi-skilled work force). The laggards have been those who have relied upon others including the government to create such an infrastructure and have spent more time lamenting the poor state of affairs rather than doing something about it.
Openness to seek access to state-of-the-art know-how and willingness to spend significant money and time acquiring it are the third differentiating factor between the winners and the also-rans. Relatively few Indian businesses, and especially those that belong to the stable of the large traditional Indian business groups, have the magnanimity to overcome the "not-invented-here" syndrome in their minds and actively seek talent, know-how, and advice from those who may be in a position to offer the same, albeit at a price. Successful companies consider the price premiums paid for cutting short the time-to-learn a small cost to incur in the overall context of their vision.
Innovation (and continuous innovation) in products and business processes is another key differentiating factor. Such skills cannot be usually acquired by merely hiring a few designers or consultants. Strategic alignment with entities that have such unique skill sets is usually a more sustainable option. The laggards either disregard the importance of cutting-edge innovation or merely end up hiring a few designers and other professionals who fail to blossom in the traditional corporate environment.
The final attribute of the winners is the ability to be decisive and act at lightning speed while factoring in for the mistakes such speed will probably entail. The laggards spend more time second guessing what mistakes may happen if the decisions were actually taken and remain paralysed with the fear of the probability of such mistakes.
How does one acquire such "value-creating" attributes? Is acquisition, local or international, the right strategy? While many Indian companies have been looking at this option seriously, I am not convinced that acquisitions can change the DNA of the acquiring business to become a more potent value-creating juggernaut. Acquisitions, when sensibly done, can give enhanced scale, reach, market access, and perhaps an opportunity to move up the value chain. However, acquisitions cannot make up for feeble vision and hesitant action. Strategic and expansive partnering to create a virtual ecosystem of bubbling enterprise, cutting edge innovation, and creative energy would be a more feasible solution.

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PPF vs NSC: What's the difference!

2007-09-17T08:19:00.000+05:30

PPF vs NSC: What's the difference?

FINANCE guru SPEAKS: This is what we attempt to do here. Explain the difference between the Public Provident Fund and the National Savings Certificate.
The NSC is a post-office savings scheme while the PPF was established by the central government in 1968. But both are very safe since they are backed by the government.

How much goes in?

The minimum amount you have to put into your PPF account in a year is Rs 500. The maximum you can put is Rs 70,000 per year.
With NSC, the minimum amount is Rs 100. Here, is no upper limit on investment.
However, NSC is sold in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000. So, if you want to invest Rs 30,000, you will have to buy three certificates of Rs 10,000 each.

What do I get?

On the face of it, both give an identical rate of interest: 8% per annum. Or so it seems.
The only difference is in the way it is computed. PPF is compounded annually. NSC is compounded half-yearly (twice a year).
Let's say on April 1, 2006, you invested Rs 30,000 in PPF and the same amount in NSC.
On April 1, 2007, your PPF account will have Rs 32,400 while your NSC will have Rs 32,448.

What's the Tax Impact?

The most important issue!
Both these investments fall under Section 80C. That means the investments made under this section are eligible for an income deduction upto a maximum Rs 1,00,000.
This is as far as your principal investment goes.
Let's look at the interest earned.
With PPF, you pay no tax on the interest you earn.

What about NSC? Till FY 2004-'05, an individual could avail of a deduction under Section 80L of the Income Tax Act. This limit was Rs 12,000 of interest income received during the financial year. This deduction has been done away with from FY 2005-'06. Now, all interest income is taxable at the respective slab rate of the individual.
The interest accrued on NSC is taxable. But, it is also eligible for a deduction under Section 80C.
Generally, it is advisable to declare accrued interest on NSC on a yearly basis. So, over the period of six years, you could declare the interest income for each year. In such a case, it does not amount to a huge sum.
If you do not declare the interest on accrual basis, then the entire interest earned (difference between the amount deposited and the maturity value) would accumulate in the year of maturity. You could then claim it under Section 80C but it would be a huge amount and would be taxable at the current applicable tax rate.

How long do I hold it?

PPF is for 15 years, but you can extend it for a block of five years. Let's say you open a PPF account when you are 21 years old. It matures when you are in your late 30s, when you may be earning well and may not need the money. In that case, you can continue with the account.
Of course, you do have the option of withdrawing the entire balance on maturity, that is, after 15 years of the close of the financial year in which you opened the account.
So, if you opened it in FY 2006-07 (this financial year), you will be able to withdraw it 15 years later, starting March 31, 2007 (end of this financial year). That is April 1, 2022.
If you extend it for five years after that, you continue to earn the rate of interest and can also make fresh deposits and get the tax benefit.
NSC is for a much shorter duration -- just six years from the date of investment.

How many can I have?

Once you open an NSC, you can't keep adding to it. You will have to buy another. Let's say you buy a NSC of Rs 30,000. In a year's time, you want to add another Rs 30,000. You cannot add it to this amount. You will have to buy another NSC.

With PPF, you can have just one account. But this does not matter because you have to make annual additions. Every year, you keep adding to it.
However, if you like the safety of the investment and a guaranteed return of 8% per annum, you can open one in your child's name. So you can have one account for yourself and one for your child. But this does not mean the tax benefit is doubled. The limit is the same -- Rs 70,000, irrespective if it all goes in your account or in your account and your child's.
Let's say you open an account for your minor child. You can deposit Rs 70,000 in your account and Rs 70,000 in your child's account. But you will only get the tax benefit on Rs 70,000.

How is it held?

The PPF account cannot be held jointly. You can nominate someone but it cannot be jointly held with someone else. With NSC, you can hold it jointly or you can hold it singly and nominate someone.

Where can I open it?

To open a PPF account, you can drop by a State Bank of India branch. No, you do not have to have an account with them.
You can also ask your nationalised bank where you have an account if they are authorised to open PPF accounts. You can also approach the head post office in your area. If that is inconvenient, ask your local post office (selection grade sub post offices are allowed to do so).
To buy an NSC, just approach any post office.

Also Read:

What is PPF

What is NSC

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