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ACKNOWLEDGEMENT

Effort is work and no work is accomplished on its own. It is the achievement of


entire human effort and teamwork. So I would like to acknowledge all those who
made this work possible.
First, I would like to express my most sincere and profound gratitude to Ms.
Versha Bansal (lecturer), Department of Management Studies, Shivdan Singh
Institute of Technology and Management, Aligarh (Affiliated to UP Technical
University, Lucknow) for her continuous guidance, creative thoughts and
perceptive comments at various stages under whose able supervision this work
has been completed.
I would also like to thank all those who have directly or indirectly helped me in
completing my project.
Having

expressed

these

thoughts,

am

at

once

aware

that

such

acknowledgement projects either the depth or the extent of my gratitude to the


few mentioned and to the whole host unmentioned helpers.

EXECUTIVE SUMMARY
In its most basic sense, interest rates are the price of investment funds. Low
rates indicate that either supply is abundant organic demand is weak. On the
other hand, high rates imply that demand is robust in relation to supply.
The amount of that premium depends on expectations, which are

influenced by

actual experience over the previous few years, plus investors' confidence.

On

the other hand, short-term interest rates are far more volatile and more complex.
The way you invest in bonds for the short-term or the long-term depends on your
investment goals and time frames, the amount of risk you are willing to take and
your tax status. Investment planning can be considered as a combination of
seven steps: Setting investment goals, Understanding your investment
personality, Designing an investment portfolio, Evaluating markets and
investments, Selecting specific investments, Managing and monitoring the
portfolio, and finally Rebalancing or redesigning the portfolio, if needed.

This study includes the interest rate changes in some specific options and
respective change in investment flows to these options. Reasons in the mind of
small investors while deciding the investment portfolio are also a topic of study.
Effect of interest rate change can be studied based on the following points:
a) More consumption than saving;

b) Capital market becoming attractive;


c) Tax benefits available on investment;
d) Effect of these changes on senior citizens;
e) Expected disposable income in the hands of the investors
Change in interest rates has an impact on all sections of the economic classes
-the high income, middle and low income, business men and salaried.

Considering the small investment especially the salaried class they are most
adversely affected by any change in the interest rates mainly because of the
following reasons: 1. They have limited disposable income to invest
2. Are extremely risk aversive

3. Mainly invest in instruments giving assured returns and depending on


interest rates so any reduction in interest rates is also a bolt for them.

For the small investors belonging to the business class interest rates are
important but with their higher risk taking capability vis a vis the impact is lower.
Valuation and ease of exit for investors are the most important considerations.

TABLE OF CONTENTS
S. No.

1.

2.

Topic

Page
No.

Certificate

Acknowledgement

II

Executive Summary

III

Impact of interest rates on small investors: An overview

Research Methodology:
Objective

Type of research
Sources of Data collection
Sampling Methods

3.

Interest rate based investment options


Bonds
Other investment schemes

20

Investment parameters
4.

Impact of liquidity

Impact of risk

Impact of tax benefits

Impact of interest rates

5.

Results and Analysis

6.
7.

Conclusion
Implications for small investors
Text and Reference
Annexure
Questionnaire
Data on interest rates

32

IV
V

CHAPTER- I
INTRODUCTION
Impact of interest rates on small investors: An overview

An individual who purchases small amounts of securities for


him/herself, as opposed to an institutional investor, is called an
individual investor, retail investor or small investor.
People work hard for money and, if they're fortunate, have some left
over after paying the costs of living. They want to commit that extra
money to earning a financial return but realize that savings accounts,
while insured by the FDIC, provide only limited interest income.
Expanding the portfolio to include investments that have the potential
to provide greater returns seems to be the solution.
Interest is the price that someone pays for the temporary use of
someone elses funds. To repay a loan, a borrower has to pay
interest, as well as the principal, the amount originally borrowed.
It is the compensation that someone receives for temporarily giving
up the ability to spend money. Without interest, lenders wouldnt be
willing to lend, or to temporarily give up the ability to spend, and
savers would be less willing to defer spending.
Lower interest rates make it easier for people to borrow in order to
buy cars and homes. Purchases of homes, in turn, increase the
demand for other items, such as furniture and appliances, thus
providing an additional boost to the economy.

Lower interest rates mean that consumers spend less on interest


costs, leaving them with more of their income to spend on goods and
services.

Lower

interest

rates

make

it

easier

for

farmers,

manufacturers, and other businesses to borrow to invest in


equipment, inventories, and buildings. Also, the returns that
investments will produce in future years are worth more today when
rates are low than when rates are high. That gives business more of
an incentive to invest when rates are low. Increased business
investment, in turn, makes the economy grow faster, as productivity,
or output per worker, increases faster. Interest rates do not seem to
affect the amount that people save. Thats because higher interest
rates have two conflicting effects on how much people save. First, the
higher return that savings can earn gives people an incentive to save
more. Second, however, the higher return makes savers feel richer,
so they may spend more, rather than save more.
The way one invest in bonds for the short-term or the long-term
depends on ones investment goals and time frames, the amount of
risk they are willing to take and the tax status.
It may be helpful to think of investment planning as a seven-step
process:
Setting investment goals,
Understanding your investment personality,
Designing an investment portfolio,
Evaluating markets and investments,
Selecting specific investments,

Managing and monitoring the portfolio, and finally


Rebalancing or redesigning the portfolio, if needed.
There is no denying the fact that in a situation where investing is for
the sake of assuring greater returns, changes in interest rates has an
impact on all sections of the economic classes -the high income,
middle and low income, business men and salaried and if interest
rate fluctuation effect the small investors then actually why these
changes take place? The answer lies behind the RBIs monetary
policies. These interest rate regimes have an impact on both
investment and consumption. Since, the list of investment avenues
last long, the scope of the study is restricted to a few most common
governmental and non-governmental investment options.
Non-Governmental options
ICICI Infrastructure Bonds
RBI Relief Bonds
IDBI Bonds
Fixed Deposits

Governmental options
National Saving Certificates
Provident Fund
LIC

The study includes the interest rate changes in above options and
respective change in investment flows to these options and the
reasons in the mind of small investors while deciding the investment
portfolio are also a topic of study.

CHAPTER II
RESEARCH METHODOLOGY
Objectives
Type of research
Sources of Data collection
Sampling Method
Limitations

OBJECTIVE:
As evident from the title the study proposes to assess the impact of
interest rates on the investment objectives of the small investors.
However, the specific objective of the study can be enumerated as
follows:
To develop the conceptual understanding of some interest
based investment option available in the market for small
investors.
To study in detail specific bonds and schemes and there
attractiveness vis a via the following:
1. Interest rates
2. Liquidity
3. Risk attached
4. Tax benefits
To identify the factors that affects the investment decision of
small investors in general.
To study the impact of change of the interest rates in particular
On the investment decision of small investors.

TYPE OF RESEARCH:
A mix of descriptive and exploratory research has been taken up.
Descriptive study based on secondary data sources has been
conducted and to validate the results of secondary data search
primary data has also been collected.

SOURCES AND TECHNIQUES OF DATA COLLECTION:


Various financial magazines, journals, newspapers, books and
Internet have been explored in order to gather secondary data.

Various published sources by government, various web sites


will act as a support to the study.

To collect primary data a questionnaire has been administered.

TYPE OF SAMPLING:
In order to define the sample non-probability judgmental sampling
has been undertaken whereby two classes of investors have been
taken up: salaried and business class:
Small investors in Aligarh
Sample size: 55

SCOPE OF THE STUDY:


The interest rate regimes have an impact on both investment and
consumption. Since, the list of investment avenues last long, the
scope of the study is restricted to a few most common governmental
and non-governmental investment options.
The study includes the interest rate changes in selected options
and respective change in investment flows to these options and
The reasons in the mind of small investors while deciding the
investment portfolio are also a topic of study.

LIMITATIONS

1. This study is merely an attempt to understand the general


impact of interest rate regime on small investors in a more
practical way but cannot be taken as a guide to the investors.
2. The reliability of the data collected and analysed depends upon
the source of the

data.

3. Due to paucity of time questionnaire could be administered to


only 55 respondents.

CHAPTER III
INVESTMENT OPTIONS
Bonds
Other Investment Schemes

BOND
Face value or par value is the value of the bond (amount of principal)
printed on the certificate and received at maturity. If interest rates
change and you need to sell Bond A before maturity, the value you
receive may change. If interest rates increase, Bond A may sell at a
discount or less than the face value. In this case, investors can buy
Bond B paying higher rates so they are not as interested in this Bond
A. If interest rates decrease, Bond A may sell at a premium because
other investors would be willing to pay more for the higher interest
rate on Bond A. See the example on page 5 of this fact sheet.
Coupon Rate (also known as coupon, coupon yield, stated interest
rate) is the interest rate printed on the bond certificate when the bond
is issued. It usually is stated as an annual fixed rate typically paid
every six months to the investor.
Maturity date is the day when the face amount of the bond must be
repaid and the debt retired. The coupon rate remains the same until
the maturity date. Bond maturities may run from a few months to 40
years.
A call feature allows the issuing agency to pay the investor the face
amount for the bond and buy back the bond before maturity. This
allows the issuer to then reissue the bond at lower interest rates. In
the event a bond is called, investors may then need to reinvest their

money at lower interest rates as well. This results in reinvestment


rate risk.
Default is the failure of the issuer of the bond to make payment on
the interest or money borrowed. Thus, the investor can lose money.
Tax-equivalent yieldIf you are buying municipal bonds for the
state in which you live, the interest may be free of federal, state, and
local income taxes. (You still may have to pay capital gain taxes if you
sell the bonds at a premium.) These income tax-exempt bonds are
appropriate for investors with marginal tax rates of 28% or higher.
There are charts that compare taxable and tax-free yields for different
marginal tax rates.
When considering a bond investment strategy, remember the
importance of diversification. As a general rule, its never a good idea
to put all your assets and all your risk in a single asset class or
investment. You will want to diversify the risks within your bond
investments by creating a portfolio of several bonds, each with
different characteristics. Choosing bonds from different issuers
protects one from the possibility that any one issuer will be unable to
meet its obligations to pay interest and principal. Choosing bonds of
different types (government, agency, corporate, municipal, mortgagebacked securities, etc.) creates protection from the possibility of
losses in any particular market sector. Choosing bonds of different
maturities helps one manage interest rate risk.

All investments offer a balance between risk and potential return. The
risk is the chance that one will lose some or all the money one
invests. The return is the money one stand to make on the
investment.
The balance between risk and return varies by the type of investment,
the entity that issues it, the state of the economy and the cycle of the
securities markets. As a general rule, to earn the higher returns, one
has to take greater risk. Conversely, the least risky investments also
have the lowest returns.
The bond market is no exception to this rule. Bonds in general are
considered less risky than stocks for several reasons:

Bonds carry the promise of their issuer to return the face value
of the security to the holder at maturity; stocks have no such
promise from their issuer.

Most bonds pay investors a fixed rate of interest income that is


also backed by a promise from the issuer. Stocks sometimes
pay dividends, but their issuer has no obligation to make these
payments to shareholders.

Historically the bond market has been less vulnerable to price


swings or volatility than the stock market.

The average returns from bond investments have also been


historically lower, if more stable, than average stock market returns.
The relationship between interest rates and bond fund performance is
sometimes over-simplified in media sound bites about investment

markets. We hear gloom-and-doom predictions for bond investors


when rates begin to rise.
Of course, bond funds are not stable value investments and involve
risk. Their value is affected by changes in the direction of interest
rates. As interest rates rise, bond prices decline, and vice versa. But
in reality, both rising and falling interest rates can offer advantages to
bond investors:

When rates rise, bond prices can be expected to fall; yet higher
rates can mean higher returns on reinvested bond income.

When rates fall, bond prices can be expected to rise, potentially


boosting a fund's return.

What's the practical application? How should interest rates affect your
bond-fund investment decisions? You'll want to talk with your financial
advisor about your own situation, but in general what's true in stock
investing is true in bond investing as well:

- You make portfolio decisions based on one goals, ones attitudes


about investment risk, and the time until one'll need to begin using
money from one s investment.
And, if rising rates are a concern, remember that a bond fund's
duration (essentially, the average time to maturity of all its holdings)
can suggest how interest rates might affect performance. The longer
the fund's duration, the more susceptible it is in the short term to
rising rates. For example, if rates rise 1%:

A fund with a 3-year duration might be expected to lose about


3% of its value.

A fund with a 10-year duration, however, might be expected to


lose about 10% of its value.

Bond funds can play an important role because they help diversify
your portfolio and produce investment income.
OTHER INVESTMENT SCHEMES

1) BANK DEPOSITS
When you deposit a certain sum in a bank with a fixed rate of interest
and a specified time period, it is called a bank Fixed Deposit (FD). At
maturity, you are entitled to receive the principal amount as well as
the interest earned at the pre-specified rate during that period. The
rate of interest for Bank Fixed Deposits varies between 4 and 11 per
cent, depending on the maturity period of the FD and the amount
invested. The interest can be calculated monthly, quarterly, halfyearly, or annually, and varies from bank to bank. They are one the
most common savings avenue, and account for a substantial portion
of an average investor's savings. The facilities vary from bank to
bank. Some services offered are withdrawal through cheques on
maturity; break deposit through premature withdrawal, and overdraft
facility etc.
Duration
15-30 days
30-45 days
46-90 days

Interest rate (%) per annum


5-7 %
5-8 %
6-8 %

91-180 days
181-365 days
1-1.5 years
1.5-2 years
2-3 years
3-5 years
5 years

6.5-9.5 %
7-9.5 %
8.5-10.25 %
8.5-10.5 %
9-10.5 %
9.5-10.5 %
9.5-11 %

INVESTMENT OBJECTIVES
While a Bank FD does provide for an increase in your initial
investment, it may be at a lower rate than other comparable fixedreturn instruments. Since capital appreciation in any investment
option depends on the safety of that option, and banks being among
the safest avenues, the increase in investment is modest.
A Bank FD does not provide regular interest income, but a lump-sum
amount on its maturity. Since the lump-sum amount depends on the
rate of interest, currently between 4 and 11 per cent, Bank FDs are
not suitable for regular income.
With a fixed return, which is lower than other assured return options,
banks cannot guard against inflation. In fact, this is the main problem
with Bank FDs, as any return has to be calculated keeping inflation in
mind.
Yes, in some cases, loans up to 90 per cent of the deposit amount
can be taken from the bank against fixed deposit receipts.
RISK CONSIDERATIONS
A Bank FD does not provide regular interest income, but a lump-sum
amount on its maturity. Since the lump-sum amount depends on the
rate of interest, currently between 4 and 11 per cent, Bank FDs are
not suitable for regular income.

With a fixed return, which is lower than other assured return options,
banks cannot guard against inflation. In fact, this is the main problem
with Bank FDs as any return has to be calculated keeping inflation in
mind.
Yes, in some cases, loans up to 90 per cent of the deposit amount
can be taken from the bank against fixed deposit receipts.
One cant be assured of Getting Back full investment. Since all the
banks operating in the country, irrespective of whether they are
nationalized, private, or foreign, are governed by the RBI's rules and
regulations, which give due weightage to the interest of the investor,
there is little chance of an investment in a bank deposit going under.
In fact, till recently, all bank deposits were insured under the Deposit
Insurance & Credit Guarantee Scheme of India, which has now been
made optional. Nevertheless, bank deposits are still among the safest
modes of investment. The thing to consider before investing in a FD
is the rate of interest and the inflation rate. A high inflation rate can
simply chip away your real returns. So, it is critical to take the inflation
rate into consideration to arrive at the real rate of interest.
Bank FDs are not commercially rated. Since Bank FDs are extremely
secure; the only thing to check out while investing in one is the
interest rate being offered and your convenience.
BUYING, SELLING, AND HOLDING
Minimum investment in an FD varies from bank to bank. It could be
as low as Rs 500 in case of nationalised banks, and could go up to
Rs 10,000 in private banks and Rs 50,000 in some foreign banks.
Banks are free to offer interest rates on their FDs, depending on the

interest rate scenario, the government's monetary policy, and their


own money supply position. Bank FDs have varying duration: from 15
days to more than 5 years. Depending on their duration, the interest
also varies.
A bank FD can only be encashed from the bank it was taken from.
Bank FDs are liquid to the extent that premature withdrawal of a bank
FD is allowed. However, that involves a loss of interest.
Since Bank FDs cannot be sold in the market; they do not have a
market value. Individual banks, keeping the market forces in mind,
determine the interest on a Bank FD.
Banks periodically mail account statements or issue passbooks
through which you can track your account status
MODE OF HOLDING A BANK FD
When a depositor opens an FD account with a bank, a passbook or
an account statement is issued to him, which can be updated from
time to time, depending on the duration of the FD and the frequency
of the interest calculation.
TAX IMPLICATIONS
Interest income from a Bank FD qualifies for exemption under section
80L, which means that interest income up to Rs 9,000 is tax-exempt.
2) NSC - 6 yrs. National Savings Certificate
Rate

of Interest @ 8 % (compounded half yearly) payable on

Return:
maturity
Limit on No Limit
Annual

Investmen
t
Tax benefits are available on amounts invested in NSC
under section 88, and exemption can be claimed under
Tax

section 80L for interest accrued on the NSC. Interest

Benefit

accrued for any year can be treated as fresh investment in


NSC for that year and tax benefits can be claimed under
section 88.
If encashed prematurely, within a year of issue, then only
the face value is given. If encashed after a year but before
3 years, then simple interest on the face value, at the rate

Liquidity

applicable from time to time, will be paid. The difference


between the accrued interest and the simple interest is the
discount rate. The Government from time to time specifies

Risk

the discount rate.


No Risk

3.) PUBLIC PROVIDENT FUND SCHEME


Returns :Interest 8.0% p.a. (compounded annually) is credited to the
PPF account at the end of each financial year.
Investment Limitation : Min Amount : Rs. 500/- and additional
investment in multiples of Rs 5/-.
Max Amount: Rs. 70,000/Scheme Availability: A PPF account can be opened at anytime

during the year. It is open all through the year.


Mode of Operation: Single, Joint (Two or more) Minor with
parent/guardian, HUF
Nomination: Nomination can be done at the time of opening the
account or during the tenor of the account.
Tenure of Investment: 15 years from the date of initial investment
with a block of 5 years there-after upto a max of 30 years incl. 15
years.
Maturity: The PPF account matures after 15 years. One can then
exercise on option of continuing the account for an additional block of
5 years or close it.
Loans
The first loan can be taken in the third financial year from the date of
opening of the account, or upto 25% of the amount at credit at the
end of the first financial year. The facility can be availed of any before
expiry of 5 years from the end of the year in which the initial
subscription was made. The loan is repayable either in lumpsum or in
convenient installments numbering not more than 36. Interest at 1%
would be charged if loan is repaid in 36 months. Such interest should
of loan is not repaid within 36 months, interest on outstanding amount
of loan would be charged at 6%.

Withdrawal
A withdrawl is permissible every year from the seventh financial year
of the date of opening of the account, of an amount not exceeding
50% of the balance at the end of the 4th proceeding year or the year
immediately proceeding the year of the withdrawal, whichever is
lower, less the amount of loan if any.
Tax Benefits: Tax benefits can be availed under sections 88 for the
amount invested. Interest accrued is Tax-free.
Tips for Investing
Apart from a Post Office, a PPF account can also be opened in SBI &
its associates and other select nationalized banks.
The most popular tax saving instrument, which gives a rebate under
section 88.
A PPF account cannot be attached by the Govt. or any court of law or
through any decrees.
4.) LIFE INSURANCE POLICIES
Life Insurance Corporation of India offers various Endowment and
Money Back policies for self and family members like Jeevan
Surabhi, Jeevan Sarita, Jeevan Saathi, Jeevan Sneh, for working

women and Jeevan Chhaya, Jeevan Sukanya for children. The


endowment policy is the most popular form of life insurance as it
makes the provision for the family in the event of early death of the
assured and also it assures a lump sum amount at a desired age.
The amount paid as premium on the above policies qualify for rebate
U/s 88 of the IT Act, 1961.

5.) RBI BONDS


RBI Bonds are tax saving bonds that have a special provision that
allows the investor to save on tax. These Bonds are instruments that
are issued by the RBI, and currently has two options one carrying
an 8% rate of interest p.a., which is taxable and the other one carries
a 6.5% (tax-free) interest p.a. The interest is compounded half-yearly
and there is no maximum limit for investment in these bonds. The
maturity period of the 8%(taxable) bond is 6 years and that of the
6.5%(tax-free) bond is 5 years. Application forms for RBI Bonds are
available and accepted at all branches of the Reserve Bank of India,
designated branches of the SBI, and designated branches of
nationalised banks across the country.
INVESTMENT:

The minimum investment on RBI Savings Bonds is Rs 1,000.


You can apply in multiples of Rs 1,000 thereafter. There is no
prescribed upper limit to your investment in this instrument.
INTEREST RATES:

Under the cumulative option of the 6.5%(tax-free) RBI Relief


Bond issued at a face value of Rs 1,000 would be redeemed at
Rs 1,377 on maturity (after 5 years). And in case of the
cumulative option of the 8% (taxable) RBI Relief Bond issued at
a face value of Rs 1,000 would be redeemed at Rs 1,601 on
maturity (after 6 years).
You can opt to receive interest either on a half-yearly basis or
on maturity of the instrument, along with the principal invested.
If you opt to receive interest on a half-yearly basis, you will
receive interest every six months from the date of issue of the
bond up to 30th June or 31st December, whichever is earlier.
Interest is paid on 1st July and 1st January each year.
MATURITY:

The period of holding of 6.5 per cent (tax-free) RBI Relief Bond
is 5 years from the date of issue. And for the 8 per cent
(taxable) RBI Relief bond, the maturity period is 6 years. The
bonds are repayable on the expiration of the maturity.
PREMATURE WITHDRAWL:

While the 8 per cent taxable Savings Bond cannot be


redeemed prematurely and must be held for the entire duration
(6 years), the 6.5 per cent tax-free Savings bond can be
redeemed before the maturity period of 5 years. In this case,
after a minimum lock in period of 3 years from the date of issue,
an investor can surrender the bond any time after the 6th half
year but redemption payment will be made on the following
interest payment due date. Thus the effective date of premature

encashment will be 1st July and 1st January every year.


However, 50% of the interest due and payable for the last six
months of the holding period will be recovered in such cases
both in respect of cumulative and non-cumulative Bonds.
LOAN FACILITY:

RBI Savings Bonds are not eligible as collateral for loans from
banks,

financial

institutions

and

Non-Banking

Financial

Company (NBFC) etc.


TRANSFERRABLE:

RBI Savings Bonds are not tradable in the secondary market.


The Bonds in the form of Bond Ledger Account and Stock
Certificate are not transferable except by way of gift to a relative
by execution of appropriate Transfer Form and execution of an
affidavit by the holder.
DETERMINATION OF MARKET VALUE OF RBI Savings

Bonds:

Market value of RBI Relief Bonds is determined on the basis of


prevailing (6.5 per cent and 8 per cent, as applicable) interest
rates and market conditions.
MODE OF HOLDING:

RBI Savings Bonds can be held at the credit of the holder in an


account called BLA or in the form of PN. The bond can be held
in demat form, i.e., a certificate of holding will be issued to the
holder of bonds in the BLA. The bonds in the form of BLA are
issued and held with the public debt offices of the RBI or any

branch of a scheduled bank authorized by the RBI. The bonds


in the form of PN are issued only at the offices of RBI. However,
bonds issued in one form will not be eligible for conversion into
the other.
TAX IMPLICATIONS:

In case of the 6.5 per cent RBI Savings Bond, the interest
received is completely exempt from income tax as per the
provisions of the Income Tax Act, 1961. But, In case of the 8 per
cent RBI Savings Bond, the interest will be taxable under the
Income-Tax Act, 1961 as applicable according to the relevant
tax status of the bondholder. RBI Savings Bonds are exempt
from Wealth Tax. However, there is no tax benefit on the
amount invested in these bonds

6.) ICICI BONDS IN THE MARKET


On July the 20th, ICICI announced the opening of its issue of ICICI
Safety Bonds. The issue is open till August 3. After IDBI exercised its
call option on its bond, it is relief to find that the ICICI bonds do not
have any Put or Call option. The issue has got the highest credit
rating with CARE assigning AAA and a LAAA from ICRA. The rating is
for Rs. 40 bn with a 100% greenshoe option.
The issue has three types of investible bonds:

Tax saving Bond

Regular Income Bond and

Money Multiplier Bond.

Tax Saving Bond:

The tax saving Bond is designed to allow people to take benefit of the
Section 54EA of the IT act. This means that if you have capital gains
occurring on transfer of long-term assets before 31 st March 2000,
then the same can be invested in these bonds within six months from
the date of such a transfer. The amount invested needs to be locked
in the investment for atleast 3 years.
Tax saving Bond has 3 options:

Option

Issue Price Rs.

5000

5000

5000

Redemption Value Rs.

5000

5000

6825

Tenure
Rate of Interest %
Frequency of interest
Yield %
Minimum Application

3
years
9.5

3 years
10.0

Monthl Annuall
y

9.92

10.0

3
bonds

years

and

months
Nil
Tenure End
Nil

1bond 1 bond

Regular Income Bond:


This bond has the following features:

Option

Issue Price Rs.

5000

5000

5000

Redemption Value Rs.


Tenure
Rate of Interest %
Frequency of interest
Yield %
Minimum Application

5000
5
years
10.4

5000

5000

5 years

5 years

10.7

11.0

Monthl Half

Annuall

Yearly

10.91 10.99
3
bonds

11.0

2 bonds 1 bond

Money Multiplier Bond:


This bond is in the nature of zero-coupon bond. No interest will be
paid during the entire tenure of the bond. At the end of the tenure the
principal along with the interest will be paid together at one go. The
scheme details for this bond are as follows:

Issue Price Rs.

5000

Redemption Value Rs.

15000

Tenure

10

years

and

months

Yield

11.0

Minimum Application

1 bond

Tax Benefits: Any interest earned on these bonds is subject to TDS


for over and above Rs. 2500. The interest earned is also eligible for

deduction under section 80L, with the maximum limit being Rs.12000
under the said section.
The bonds look to be good Investment Avenue as they offer safety,
reasonable returns and ICICI brand name. Just on point though, with
the interest rates looking to head north we could see the banks
increasing their deposit accepting rates in the near future. That could
be worth a look. Different investment options available for investors
with different risk profiles: 7.) EQUITY DIVERSIFIED FUNDS
Diversification - Mutual Funds reduces the risk by investing in all the
sectors. Instead of putting all money in one sector or company it's
better to invest in various good performing sectors as it reduces the
risk of getting involved in a particular sector/company which may
perform or may not.
Who should invest - This is an ideal category for those who want to
participate in stock market & knows the risk involved in stock market
but have few rupees to invest in blue-chip stocks.
How they performed - Though the short term out look is volatile in
long-term equity diversified funds have outperformed other categories
& stock markets will lesser amount of risk than stock markets. The
average returns of equity-diversified funds are 102%.

Performance as on March 25, 2004


Absolute Simple Annualized
Scheme Name

NAV

3 Months 1 Year 3 Years Since Inception

HSBC Equity

26.27

2.34

156.87 -

124.24

India Advantage 89.57

5.58

150.63 49.44

104.25

Reliance Growth 71.84

(6.29)

147.24 88.48

73.00

Average

(3.93)

102.19 40.17

33.96

S&P Nifty

1704.45 (5.76)

68.35 15.55

BSE Sensex

5414.44 (4.03)

72.21 16.27

Category Rating ****


8.) INDEX FUNDS
Follow the index - These are the index-based funds, which move
with the likes of Sensex & Nifty. These fund charges NIL or very low
entry/exit loads.
Who should invest - In the last few months Nifty & Sensex have
almost come down 17% from their tops, it is a good time to invest in
Index funds with the principal of "Investing at the lower levels".
How they performed - Though the short term out look is volatile in
long-term Sensex & Nifty could do well with improving economic
conditions. It has been seen that these Index funds have
outperformed the indices making them more attractive.

Performance as on March 25, 2004


Absolut
e
Scheme Name

NAV

Simple Annualized
1

Since

Months Year Years Inception


Junior BeES

154.2

31.87

(1.59)

HDFC Index - Sensex Plus 56.60

(3.50)

74.82 -

44.45

54.55

(4.06)

73.77 -

(5.19)

70.70 16.62 27.80

(5.76)

68.35 15.55 -

(4.03)

72.21 16.27 -

SENSEX

Prul

Exchange Traded
Average
S&P Nifty
BSE Sensex

ICICI

1704.4
5
5414.4
4

(65.83)

Category Rating - ***


9.) SECTOR FUND
Sector - Sector Schemes follow particular sector.
Who should invest One has to be selective while investing in
these funds, as one need to select particular sector, which will
perform better in the future. Investing in these funds carries some
amount of risk but also give more returns.
How they performed - Sector funds have given average returns of
73% for 1 year period. Auto, Steel, Cement have done well the year
'03 & the trend will continue in year '04 but IT, FMCG sectors are
experiencing downward trend due to $ depreciation, price war in
FMCG respectively. Though short-term trend for pharma sector looks

down in long term we look forward to lot more action in the sector, as
there exists a long-term, strong fundamental story backed by
immense growth potential for the Indian pharmaceutical companies.

Performance as on March 25, 2004


Absolut Simple
e
Scheme Name

NAV

3
Months

Alliance Basic Industries 27.82 1.20


UTI Growth Sector Petro
SBI Magnum Sector Pharma
Average
S&P Nifty
BSE Sensex

Annualized
1 Year 3 Years

Since
Inception

135.99 83.23

42.48

18.37 3.77

120.55 76.94

82.88

15.82 (9.24)

111.78 32.15

15.58

(7.98)

72.60 23.57

16.36

(5.76)

68.35 15.55

(4.03)

72.21 16.27

1704.4
5
5414.4
4

Category rating - **
10.) BALANCED FUNDS
Balanced Act - Balanced funds gives you the stability with the
potential to grow with the equity help of equity investments. These
funds invest in both Equity & Debt markets.

Who should invest - The balanced funds are for those, who want to
enjoy the appreciation effects of equity market but at the same time
like to play safe with less volatile debt market. In this volatile market it
is good to invest in balanced funds as they carries less risk compare
to equity funds.
How they performed - In the last 12 months balanced funds have
given descent returns with the up trend in the equity markets.
Balanced funds average returns are 60% for 1-year period.

Returns as on March 25, 2004


Absolute Simple Annualized
Scheme Name
HDFC Prudence
SBI

NAV
44.0
9

Magnum 12.8

Months Year
(1.63)

81.68 51.24

46.59

2.07

80.44 21.88

23.21

77.54 16.83

(3.75)

Balanced

Franklin India Vista

8.39 (1.06)

Average
S&P Nifty

3 Years Since Incep.

(2.05) 60.54
1704.45 (5.76) 68.35

27.5
4
15.5
5

Crisil Balanced Index 1409.12 (1.07) 45.22 Category rating - ***

18.15
-

11.) EQUITY LINKED TAX SAVINGS SCHEMES (ELSS)


Enjoy tax benefits - These schemes are becoming more popular as
traditional ways of tax saving becoming less interesting with declining
interest rates.
Who should invest - Equity Linked Savings Schemes (ELSS) is an
ideal way to save on tax as well as staying invested in equity mutual
funds.
How they performed - In last 1 year these funds have given above
average returns to keep you more & more interested in saving tax as
well as counting returns on investment. The average returns for this
category are 98%.

Performance as on March 25, 2004


Absolute Simple Annualized
3

NAV

Birla Equity

26.90

(6.11)

137.32 53.56

46.87

23.03

(3.43)

136.95 26.61

16.66

Tata Tax Saving

23.35

(2.73)

133.08 50.26

60.09

Average

(5.48)

98.30 37.17

51.73

S&P Nifty

1704.45 (5.76)

68.35 15.55

BSE Sensex

5414.44 (4.03)

72.21 16.27

Magnum Tax Gain


93

Category rating - ****

Months

1 Year 3 Years

Since

Scheme Name

Inception

12.) DEBT FUNDS


Banking on Debt Markets - Debt funds invest in the government
securities, Corporate Bonds, Treasury Bills, etc.
Who should invest - The conservative investors like to go for capital
safety.
How they performed - From Last 12 months in the declining interest
rate scenario debt funds remained flat. In 3 years debt funds have
given average returns of 12%. As equity market is looking volatile its
better to invest part of money in these funds.

Performance as on March 25, 2004


Absolut
e
Scheme Name
Deutsche Premier Bond -

NAV

Simple Annualized
1

Since

Months Year Years Inception

11.17 3.31

13.65 -

9.93

12.11 2.83

12.17 -

13.43

11.39 3.04

11.88 -

10.61

Average

9.07 13.98 10.79

S&P Nifty

1704.4 25.59

Institutional
Sundaram Select Debt - D A
P
HSBC Institutional Income Invest

2.33

68.35 15.55 -

5
NSE

Sec

Composite

Index
Category rating - ***

247.17 2.64

12.61 16.80 -

13.) GILT FUNDS


Government Sec. - Gilt funds invest in government securities.
Who should invest - The investors who like to avail the benefits of
capital safety with government security.
How they performed - From Last 6-12 months Gilt funds have given
average returns. As equity market is looking volatile its better to
invest part of money in these funds as they provide adequate security
to investments. The average returns for 1-year period are 10.41%
compare to the NSE G Sec Composite Index has given 12.60%
returns.

Performance as on March 25, 2004


Absolut Simple
e
Scheme Name
FT India Gilt Investment
Plan - Growth

NAV

6
Months

14.88 5.63

Annualized
1 Year 3 Years
19.64 -

Since
Inception
21.22

Chola Gilt Investment Growth


Tata Gilt Securities Fund Growth
Average
Crisil

Composite

16.98 19.83

19.93

22.25 3.33

15.46 25.46

26.36

2.56

10.41 16.19

9.58

2.23

9.03

Bond 1203.2

Fund Index
NSE G Sec Composite
Index
Category rating - ***

17.96 6.58

247.17 2.64

12.61 16.80

14.) MIP
Monthly Income - These schemes gives you monthly income.
Who should invest - Those who seek monthly income. In the current
scenario where debt market is very volatile it's better to invest in
hybrid funds like MIP with suitable time horizon for capital
appreciation.
How they performed - In Last 6-12 months MIP's have given
descent returns compare to debt funds. The average returns of MIP's
stands at 15.68%, which looks good, compared to income funds.

Performance as on March 25, 2004


Absolute Simple Annualized

Since

NAV

Alliance MIP

19.98

8.48

20.64 17.03 21.22

FT India MIP - Plan A 15.77

7.90

19.20 16.13 16.54

SBI Magnum MIP

13.65

7.40

15.22 -

Average

6.19

15.68 14.76 7.31

25.59

68.35 15.55 -

6.15

17.34 -

1704.4

S&P Nifty
Crisil

MIP

5
Blended 1255.0

Index

Months

1 Year

Scheme Name

Years Inception

12.12

Category rating - ****

15.) STP
Short-term Plans - These schemes provides short-term saving
option with more liquidity than FD's to park investments.
Who should invest - Those who seeking for income in short-term
investments of 6-10 months with more liquidity than Bank fixed
deposit.
How they performed - While savings accounts would give 3.5% per
annum, bank FD's annually return up to 6.5%, Liquid funds would
typically give more than 5% and short-term plans 6 to 6.5% per
annum. In Last 6-12 months STP's have given descent returns.

Performance as on March 25, 2004


Absolut
e
6

Simple Annualized
1

Since

Scheme Name

NAV

First India Short Term

11.15 2.77

7.90 -

7.50

Reliance Short Term

10.89 2.81

7.30 -

7.02

Deutsche Short Maturity

10.76 2.64

7.03 -

6.47

Average

2.41

6.33 9.27

6.42

2.23

9.03 -

2.19

5.68 -

Crisil
Index

Composite

Bond 1203.2
9

CRISIL short-term Bond 1138.9


Index

Months Year Years Inception

(***** Out performer **** Good Performer *** Average Performer ** Ok


Performer * Bad Performer)

CHAPTER IV
INVESTMENT PARAMETERS
Impact of liquidity
Impact of tax benefits
Impact of risk
Impact of interest rates

In its most basic sense, interest rates are the price of investment
funds. Low rates indicate that either supply is abundant or demand is
weak. On the other hand, high rates imply that demand is robust in
relation to supply.
To best illustrate this relationship let's use long-term bonds. Supply is
made up not only of bonds currently being issued, but also all past
issued

bonds!

corporate

and

municipal,

which

can

be

interchangeable with one another. The demand side is made up


primarily of financial institutions, pension funds and insurance funds
in particular.
The amount of that premium depends on expectations, which are
influenced by actual experience over the previous few years, plus
investors' confidence.
On the other hand, short-term interest rates are far more volatile and
more complex. First look at a concept that plays an important part in
bond pricing which is the yield curve. In a positive yield curve, the
shortest-term maturities have the lowest yields. For a negative, or
inverted yield curve, the highest yields are in the shortest maturities
and the longer-term maturities have the lowest yields.
The yield curve can be eq! uated to the market structure of other
futures markets. The normal mar ket or carrying charge market has
the lowest prices in the nearest months, while an inverted market has
the highest prices in the nearest months. Inverted commodity markets
happen during periods when physical supplies are scarce, so
negative yield curves occur when money is in short supply.
The Federal Reserve, through its open-market operations, can create
periods of tight and easy money. Many economists doubt that the Fed

can have much control over bond prices, but it can influence shortterm rates greatly. The Federal Reserve will also go through periods when
controlling interest rates is not its primary aim, and instead it tries to
control the growth of the money supply, letting the market determine
the appropriate rates. Thus one of the keys to successfully trading
short-term interest-rate futures is to correctly forecast what the Fed
will be attempting to do.
Except for situations where the Federal Reserve is intervening, shortterm rates are a function o! f supply and demand. The supply consists
from

institutions

plus

individual

savings;

the

demand,

from

government plus the private sector generally. The private sector is the
swing component in credit demand.
When government deficits are high, rates will also tend to be high if
there is any strength in the economy. Government credit demand is
not responsive to high rates, but the private sector does respond. A
prolonged period of high rates eventually brings on a recession and
collapses private credit demand.
When developing a fundamental game plan to forecasting futures
prices, it is important to have a view toward interest rates, the future
road-map of the world economy, and the future strength or weakness
of the U.S. dollar. An understanding of the fundamental economics is
essential for trading in markets such as interest rates and currencies.
In addition, the economic fundamentals revealed by interest rates can
have a profound impact on the equity mark! ets as well.

IMPACT OF LIQUIDITY
Valuation and ease of exit for investors are the most important
considerations. Presently, the feasibility of an Indian company as the
primary investee has increased because of the higher valuations for
service companies on Indian stock exchanges and relaxed India
currency exchange controls. The other structuring considerations are
still relevant but valuation is the key driver.
The primary considerations in selecting an investment structure for
India are valuation and ease of exit for investors. India's strength in
providing low cost business services, the valuation of such
businesses on India's stock exchanges and currency exchange
liberalizations are causing investors to consider more India centric
investments.
Illiquidity as measured by the absence of continuous trading implies
that there
is an extreme mismatch between the available buyers and sellers at a
given point in time. The available pool of liquidity-motivated traders
(who demand immediacy) may not arrive at the same time. The
consequent order imbalance can be cleared only if there exist traders
who are willing to absorb the excess demand or supply at a price
concession, of course. In other words, the traders who want to buy
immediately can do so at a higher price and, similarly traders desiring
immediate sale have to accept a lower price. In India the liquidity
traders do not have this facility at this time, since there are neither

any pre-arranged dealers for the stocks nor a mechanism for


aggregating limit orders.
Therefore, at a given time, if there are no liquidity-motivated traders
on one side of the transaction, then one would expect no trade to
occur. The probability of the arrival of a trader - the transaction rate depends on the number of shareholders. The liquidity of the stock
can be enhanced by having a more diffused ownership but at the cost
of good internal monitoring. Also, a distinction between long-term
investors and short-term liquidity traders. The idea is that the
ownership structure affects the level of liquidity of the stock.
IMPACT OF RISK
Global markets have become increasingly volatile and inter-related.
More and more complex instruments, leveraged for increasing profits
substantially, are being tradedthe implications of which are yet to
be fully understood.
The critical question therefore is: Have all dimensions of risk, that
impact both short-term and long-term goals of liquidity, profitability
and solvency, been taken into account? This indeed is a pertinent
question, especially since risk is at the core of achieving profits.
To appreciate the magnitude of the problem, let us focus on banks.
Today, banks are faced with both credit and market risk. As per RBI
guidelines, all banks have based their capital adequacy ratio on credit
risk, whereas only one in 25 banks have accounted for market risks.
What does this mean?

Capital adequacy ratio (CAR) gives a measure of the risk cover that a
bank must have in terms of the amount of capital, in event of
defaulting creditors/risky investments to remain solvent. However, if
the entire extent of risk exposure by the bank does not form the basis
of measurement of CAR, that becomes the biggest risk of all.
Credit risk is just one aspect of risk taken by banksthe other critical
component being market risk. This is risk arising from fluctuations in
market prices and deals with interest rate risks, debt/equity risk,
foreign exchange risk and commodities risk. This risk factor currently
contributes to more than 50 percent of the banks profit margins that
is not being covered. Which indeed is a precarious situation.
Worse, the vulnerability of the situation does not end there.
Even if all the dimensions of risk are considered to calculate CAR,
there are no IT solutions in place to measure risk accurately and
dynamically, across all possible parameters/scenarios to arrive at a
sound risk management strategy. At this stage, therefore, though
there is an appreciation of the upside of risk vis--vis returns, there is
no way to measure the implications of downside risk.
So the problem is two-fold: one is of banks not taking into account
market risks while calculating their CAR, and the second is of not
being able to measure risk accurately across all its dimensions.
In other words, conventional IT systems/methods typically prove to be
inadequate to dynamically measure all dimensions of risk. To begin
with, the data is not accurate. This is plainly reflected in the crucial
risk-return ratios arrived at by key decision makers/managers,
typically based on past experience, a sense of whether the current

risk position is aggressive/moderate, and static reports from


disparate data sources. Secondly, these ratios reflect only the current
position of investments made, validated by marking to market the
existing portfolio, to arrive at the current market exposure. They do
not reflect future market risks.

Thus, traditional IT systems are neither capable of providing current


accurate data, nor can they take into account the future volatility in
marketschange in interest rates, currency market movements et al.
These external factors are the essential underlying factors of risk with
far-reaching impact on investment portfolios and CARs thereof.
Consequently, these external factors have to be identified to compute
their future impact on profit via probable what-if simulation analysis
and arrive at single measure of risk. In other words, investment
portfolios have to be marked to the future to derive the current
accurate risk exposure.
This is a critical point that cannot be emphasized enough. When the
entire extent of underlying risk factors, marked to the future, is
measured, it gives the banks the vital option of taking proactive
decisions on rebalancing its portfolio and ensuring optimal risk-return
measures. Further, it provides for the true picture of risk of current
exposures at hand to arrive at an accurate measure of CAR.
This is what Value at Risk (VAR) is all about. VAR is but one measure
of mark to future analysis, others being what-if market simulations,
sensitivity test to exposures, etc. Simply put, a one-day VAR of $10
million using a probability of 5 percent means that there is a 5 percent

chance that the portfolio could lose more than $10 million in the next
trading day. This powerful concept/data allows banks to arrive at an
accurate CAR, besides giving them the power to make informed
decisions on their existing investment portfolio. From this it emerges
that the critical success factor for these new risk measures to be
effective is for it be integrated into the decision making process.
This calls for enterprise-wide risk solutions that provide for accurate
data, measure underlying credit and market risk factors, answer
multi-dimension queries modifying them to create hypothetical
situations and if necessary quickly adapt to match changes in the
organization or market. For this, managers need to radically shift their
mindset from returns per se to measuring risk and finally to risk
adjusted returns. This is the key differentiating factor between
traditional tools and the enterprise-wide risk solutions that measure
risk for future solvency.
To conclude, in a scenario where the markets are volatile, where a
majority of profits are derived from trade, topped by the ongoing
accounting scandals epidemic, one can no longer afford to avoid
measuring the scope of risk and managing its implications thereof.
Undeniably, crossing the chasm will involve systemic changes
coupled with the characteristic uncertainty and pain that it bringsbut
it is a risk worth taking. After all, as Warren Buffet said: To finish first,
you have to first finish.

IMPACT OF TAX BENEFITS


Small investors have always been very apprehensive about the
impact of tax benefits on their investments.

Let's look at how some proposals affect taxpayers, senior citizens


and small investors.
It's noteworthy that the turnover tax will not be levied on investment in
mutual fund schemes. That's one more reason why small investors
should invest in mutual funds for their equity portfolio rather than
investing directly in the stock market.
Best post-Budget investment options
Senior citizens and individuals in zero or low tax brackets have
something to cheer about. The interest rates of various popular small
saving schemes like Post Office monthly income scheme (POMIS),
NSC, KVP and PPF have not been changed or reduced from current
8 per cent.
Senior citizens should eagerly await terms and conditions of newly
announced '9 per cent Senior Citizens Savings Scheme'.
This scheme will replace the LIC's 'Varishtha Pension Bima Yojana'
which also offers assured return of 9 per cent per annum payable
monthly.
We hope that there is no cap or maximum investment limit for the
new 9 per cent scheme for senior citizens and also that interest is
paid at monthly intervals. What is the definition of 'Senior Citizen'?
Fifty-five years, 60 years or 65 years? Lets keep our fingers crossed.

There is equally good news for high taxpayers also as 6.5 per cent
Tax Free RBI Saving Bonds and 8 per cent Taxable Bonds continue
without change. Also, dividends from open-ended equity funds
continue to be tax free in the hands of investors.
For young investors whose wealth creation strategy is based upon a
long-term equity portfolio, they should open a systematic investment
plan.
Due to volatility in interest rates (expected to continue for another six
months) investors should choose floating rate bond funds instead of
long-term income funds.
For savvy investors who understand the stock markets, investment in
shares with proper research has become highly attractive due to
much lower short-term capital gain tax rate of only 10 per cent. The
icing on the cake is that the long-term capital gains on investment in
shares has been totally abolished.

The corporate tax rate has been lowered from 36.6% currently to
33.6%, which would boost earnings for high tax paying companies by
4-5%. Personal income tax brackets have been rationalized, which
should boost disposable incomes (Rs24,000 for a taxable income of
Rs250,000). Lower import duties will further improve competitiveness
of

manufacturing

industries.

Given the markets relatively low expectations, these initiatives have


been taken positively. Further, fears that social sector spending would
lead to tax hikes have been set to rest.

Apart from the tax related boost to corporate earnings, the changes in
personal income tax should boost disposable income, and further
strengthen the ongoing consumption boom. Further, as mentioned in
our recent strategy note Riding the earnings bull we expect strong
capital expenditure to be a key driver of earnings and elongate the
earnings

cycle.

The

finance

ministers

announcements

on

infrastructure spending will boost the already bulging order books of


capital

goods

and

equipment

companies.

In our pre-budget note, we had said that if the Kelkar committee


recommendations were implemented with retrospective effect it would
be negative for IT, pharma, telecom, housing finance and other
sectors where companies had tax exemptions. Fortunately the
government has not implemented any measure that could have an
adverse impact. For instance, the government has maintained the
status quo on housing loan exemptions and continued with tax
exemptions

for

the

information

technology

(IT)

sector

and

infrastructure while extending pharma R&D tax benefits

IMPACT OF INTEREST RATES


Investors and loan seekers have been witnessing a dramatic change
in the Indian interest rate environment over the last few years. We are
not getting into the impact of this change on one's balance sheet.
What we are going to tackle here is how investors and loan seekers
must place themselves so that they can make the most of the
emerging scenario.

The Governor of the Reserve Bank of India (RBI) has said that given
the normal conditions and overall stability, in view of the structural
constraints, it is likely that the present nominal and real interest rates
are now relatively low and may not have significant potential for
further sizeable downward movement in India. (Statement from the
press release of the Reserve Bank of India on the Monetary and
Credit Policy for 2003 - 04)
In simpler terms this means that there is only a little chance that
interest rates will move down significantly from their present levels.
Not surprisingly post the monetary policy announcement; debt
markets took a bit of a beating.
Another factor that is likely to impact the interest rate environment
going forward is recovery that is underway in the domestic economy.
It is anticipated that a step up in economic activity, coupled with the
huge government-borrowing program, which shows no sign of
abating, could at some point in time exert upward pressure on
interest rates. Though not many expect interest rates to rise
significantly, but this could create volatility in the debt markets.
If

you

are

an

investor

In the last couple of years, investors in debt mutual funds raked in


large returns. Much of these returns were accounted for by capital
gains i.e. as interest rates in the market fell, the value of existing debt
securities increased. The interest component accounted for a small
percent of overall returns. This scenario is likely to reverse in the
coming years.

Leading income funds

Income

(Long NAV NAV

1-

6-

1-Yr 3-Yr 5-Yr Incep

Term) Funds
(Rs)
HDFC INCOME G 14.7

DATE Mth Mth


1 May 1.8 7.2 14.4 -

SUNDARAM

20.1

%
2 May 1.8

%
6.9

%
%
14.3 13.5 14.1 13.8

BOND A
TEMPLETON INC. 21.8

%
2 May 2.1

%
6.8

%
%
%
%
14.1 14.3 14.1 14.2

BLD ACC G
BIRLA INC B

26.2

%
2 May 1.8

%
6.4

%
%
%
%
13.6 13.6 13.4 14.6

HIGH 21.5

%
2 May 1.7

%
6.0

%
%
%
%
13.5 13.9 13.1 13.4

%
2 May 1.6

%
6.1

%
%
%
%
13.2 14.7 14.6 12.2

ZURICH

INT G
JM INCOME G

24.7

.
15.3

(Returns over 1-Yr are annualised)


Debt funds will now generate much, or rather most, of their returns
from the interest earned on the debt securities they hold. Only a small
portion of the returns will now be generated by trading (i.e. capital
gains). The overall returns will be much lower than has been the case
in the past.
So what should you do now?
Given the fact that returns from debt schemes will be much lower
going forward, investors will need to review their portfolios to ensure
that in the new environment their objectives are being met. If yes,
then probably there is not much to do except for maybe taking care of

the volatility issue. But if one is not going to be generating the kind of
income ones been expecting to, one will need to rebalance portfolio
in favour of maybe the slightly more risky schemes - like the high
interest rate funds which invest in the likes of AA quality paper
(second highest level of safety), which offer higher returns and also
the possibility of capital gains (if and when they are upgraded to AAA
quality).
If one is already invested in debt funds (income, bond and gilt) and
are likely to stay invested for a minimum of one year, there is no need
for any change due to concerns pertaining to volatility.
However, for investors who are looking at minimising the possibility of
erosion in capital even in the near term, there are the floating rate
schemes which aim at generating returns in line with the interest
rates in the market. Such schemes fulfill the role as a stabilising force
in a portfolio in times of volatility.
Floating Rate Funds will provide much-needed stability

Floating

Rate

Funds

NAV

NAV

1-

(Rs)

DATE

Wk Mth Mth Yr p.

10.1

May 2

0.1 0.4 -

GRINDLAYS

1-

6-

1-

Ince

1.1
%

FLOATING G
10.2
HDFC
LTP G

FLOATING

May 1

0.1 0.4 %

1.4
%

10.9

May 2

TEMPLETON

0.1 0.6 3.1 7.2 7.2


%

FLOAT LTP G
(Returns over 1-Yr are annualized)
As far as investors in government savings schemes are concerned,
there is unlikely to be any change in the returns offered by such
schemes. Only the EPF may see a rate cut. Going forward however,
probably post the general elections, most government savings
schemes are likely to see substantial cuts in the returns offered.
Unsustainability of Govt. Saving Schemes

Nilesh Shah, Chief Investment Office, Franklin Templeton

Investments on the Monetary Policy


For a Loan seeker
Interest rates on home loans have been declining mainly due to the
cost of money having come down and the increasing competition in
the sector. While there is doubt that there is any significant downside
in interest rates from here onwards, few expect the same to rise.
Given that this is a long-term liability, loan seekers probably are still
better off with floating rate loans. This is because expectations, even
in the near term, are of volatility and not those of rising interest rates.
And over the long term, given that the `structural constraints' would
probably have been dealt with, interest rates could probably inch
lower. On the other hand if one were to go in for a fixed rate loan, with

the expectation of switching to a floating rate loan if interest rates


were to decline, there would be significant costs that the home loan
company would levy (as high as 2% of the outstanding loan).
However, if you do not have an appetite for risk, you are better off
with a fixed rate loan.
The statement by the Governor of the Reserve Bank of India
has put to rest the speculation among retail investors and
loan seekers about the direction of interest rates going
forward. Investors and loan seekers must now align their
assets and liabilities in such a manner that they continue to
move towards achieving their long-term objectives.

CHAPTER- V
RESULTS AND ANALYSIS
For the purpose of analyzing and interpreting as to what are the factors
particularly interest rates that, affect the spirit of small investors a questionnaire
has been administered.

1. Occupation

Business

Salaried

Occupation

38%
62%

Salaried
Business

Out of the sample of 55 small investors 38% belongs to the business class and
the rest 62% are the salaried class people.

2. Name of securities purchased in the following format

Name of security

ICICI Infrastructure Bonds


RBI Relief Bonds
IDBI Bonds
Fixed Deposits
National Saving Certificates
Provident Fund
LIC

others, specify

FY 2003-04

FY 2002-03

Investment Instruments
35

No of Respondents

30
25
20
15
10
5
0

ICICI infra RBI Relief


BondsiI
Bonds

IDBI
Bonds

FD's

NSC

PF

LIC

Others

2002-03

16

29

22

19

24

27

2003-04

14

12

11

22

14

15

19

31

3. Are you aware of the interest rate changes?


Yes / No

Interest Change Awareness

29%

71%

Yes

No

The awareness about the interest rate changes among the people is rated as
71% according to the questionnare, which has been administered.

4. Weightage of factors which effect decision of investments in securities

Please assign marks to these factors according to your preference so that the
total doesnt exceed 10

Factors

Interest Rates
Tax Benefits
Risks Attached
Liquidity
Others specify

Factors Affecting Decision of Investment

28%

0
13%

Interest Rates
Tax Benefits

24%
35%

Risk
Liquidity
Others

The investment choice is largely being made on the basis of a risk (35), liquidity
(28), tax benefits (24) respectively followed by interest rates, which is only 13%.

5. Rate your awareness at the time of investment

Factors

Changes in interest rates


Tax Benefits
Risks Attached
Liquidity

Others, Specify

High

Medium

Low

Awareness At Time Of Investment


N
o
o
f

40
35
30

R
e
s
p
o
n
d
e
n
t
s

25
20
15
10
5
0
Changes in Int
Rates

Tax Benefits
High

6. Where do you gather information from?

Scale

3 - Most Important source


1 - Least Important source

Risk
Medium

Liquidity
Low

Sources

Agents
Mutual fund companies
Friends
Colleagues
Media/Advertisement
Family Members
Others, Specify

Source of Information
50

No of Respondents

45

44

40
35
30

33
29

25
20

18

16

15

12
9

10
5
0

Source

The most popular source of gathering information is friends colleagues, agents followed
by mutual fund companies and media

7. Do you find capital market more attractive in view of recent fall in interest
rates of investment?

Yes/No

Attractiveness of Capital Markets


7%

93%

Yes
No

93%people find capital market more attractive in view of the recent fall in interest
rates on investment since no other investment options seems attractive enough.

8. In view of fall in interest rates, would you like to make lesser investment
in the same investment option as compared to last year?

Yes / No / cant say

If yes then will you

(A) Spend more on Consumable items; or


(B) Invest in capital market

4%
31%
65%

Yes
No
Cant Say

CHAPTER -VI
CONCLUSION

ffect of interest rate change has been studied based on the following
points:
More consumption than saving;
Capital market becoming attractive;
Tax benefits available on investment;
Effect of these changes on senior citizens;
Expected disposable income in the hands of the investors

Change in interest rates has an impact on all sections of the


economic classes -the high income, middle and low income, business
men and salaried.
Considering the small investors especially the salaried class they are
most adversely affected by any change in the interest rates mainly
because of the following reasons: 4. They have limited disposable income to invest
5. Are extremely risk aversive
6. Mainly invest in instruments giving assured returns and
depending on interest rates so any reduction in interest rates is
also a bolt for them.

For the small investors belonging to the business class interest rates
are important but with their higher risk taking capability vis a vis the
impact is lower.
However, what has been concluded from this study is that interest
rates, in the present scenario, do not very much affect the spirit of
investors. It is just that a large chunk of small investors invests
keeping in mind the tax implications, risk attached and liquidity of
those investment options.
Investing in different instruments for small investors means
investing in different insurance companies fixed deposits has
been the most popular investment instruments followed by LIC,
NSC, PROVIDENT FUND, RBI, ICICI, IDBI BONDS.
The primary considerations in selecting an investment structure
are the risk attached, tax benefits, liquidity and interest rates in
the order of preference.
The other structuring considerations are still relevant but the
factors just mentioned above are the key drivers. It is also been
observed that the investors have high awareness of the tax
benefits they are getting as compared to the interest rates. Risk
and liquidity are following the above two on the same lines.
All the dimensions of risk, that impact both short term and longterm growth of liquidity profitably solvency has been taken into
account. In the scenario where the markets are volatile, where

the majority of profits derive from trade, topped by the ongoing


accounting scandals epidemic one can no longer afford to avoid
measuring the scope of risk managing its implication.
Small investors have always been very apprehensive about the
return and risk they get on their investments. A sound
investment option with a balance between the risk and the
return profile would be based on the information gathered from
different sources. These sources reflect the easy accessibility of
the sources of information to the investor in almost equal
proportion. The most popular sources have been found out to
be friends, colleagues, and agents followed by mutual fund
companies, media and the rest.
The fact that the small investors are finding capital market more
attractive is because that no other scheme seems attractive
enough because of the fall in the interest rates.
It has also been concluded that majority of people because of the fall
of the interest rates would make lesser investment in the same
investment option and would spend more on the consumable items.

CHAPTER -VII
IMPLICATION FOR SMALL INVESTORS

Like a tuft of green grass that pops up in the bleak, brown yard after a
long winter, fixed-income interest rates are showing signs of life.
While borrowers fret about rising loan rates, folks who like to stash
cash in certificates of deposit are enjoying the prospect of heftier
income on their bank statements.
In a rising interest-rate environment, the name of the game is to stay
flexible -- find the highest rate for the shortest term so you're not
stuck when rates climb. Be sure you can move your investment to a
higher rate if rates spike at your bank.
Fixed deposits remain the most popular instrument for financial
savings in India. They are the middle path investments with adequate
returns and sufficient liquidity. There are basically three avenues for
parking savings in the form of fixed deposits. The most common are
bank deposits. For nationalized banks, the yield is generally low with
a maximum interest of 10 to 10.5% per annum for a period of three
years or more. As opposed to that, NBFCs and company deposits are
more attractive.
The idea is to select the right company to minimize the risk. Company
deposits as a saving instrument have declined in popularity over the
last three years. The major reasons being the slowdown in economy
resulting in default by some companies. Also, some NBFCs simply
vanished with the depositors' money.
All that is likely to change for the better. Corporate performance is
likely to improve and stricter control by RBI should improve NBFCs
record. But one still needs to be selective.

Post office is a very safe and secure investment avenue. The money
is used in the development of the society as a whole, while it provides
steady returns. The biggest advantage of investing in post office
schemes is the tax benefit that they provide. Thus a lot of savings go
through this channel to dual advantage - The term "fixed" in fixed
deposits denotes the period of maturity or tenor. Fixed Deposits,
therefore, presupposes a certain length of time for which the
depositor decides to keep the money with the bank and the rate of
interest payable to the depositor is decided by this tenor. The rate of
interest differs from bank to bank and is generally higher for private
sector and foreign banks. This, however, does not mean that the
depositor loses all his rights over the money for the duration of the
tenor decided. The deposits can be withdrawn before the period is
over. However, the amount of interest payable to the depositor, in
such cases goes down (usually 1% to 2% less than the original rate).
Moreover, as per RBI regulations there will be no interest paid for any
premature withdrawals for the period 15 days to 29 or 15 to 45 days
as the case may be.
Things To Look Out For....

Credit rating/ reputation of the group

The rating is possibly the best way to judge the credit


worthiness of a company. However, for manufacturing company
deposits, it is not mandatory to get a rating. In such cases, it is
better to check the size and reputation of the company or the
industrial group it belongs to.

Interest rate

Within the same safety level (or rating), a higher interest rate is
a better option. The difference in some cases can be as high as
1%.

Diversify

The portfolio principle applies to company deposits also. It is


always better to spread deposits over different companies and
industries so as to reduce risk.

Period of deposit:

The ideal period for a company deposit is 6 months to one year


as it offers the liquidity option. Also, it gives an opportunity to
review the company's performance.

Periodic

review

of

the

company:

As your principal and interest rests in the hand of the company,


it

is

advisable

to

review

the

company's

performance

periodically. This, however, does not mean that the depositor


loses all his rights over the money for the duration of the tenor
decided. The deposits can be withdrawn before the period is
over. However, the amount of interest payable to the depositor,
in such cases goes down (usually 1% to 2% less than the
original rate). Moreover, as per RBI regulations there will be no
interest paid for any premature withdrawals for the period 15
days to 29 or 15 to 45 days as the case may be.
Other than banks, there are non-banking financial companies and
companies who float schemes from time to time for garnering

deposits from the public. In the recent past, however, many such
schemes have gone bust and it is very essential to look out for
danger signals before putting all your eggs in one basket.
Why should you invest in Mutual Funds?
1) Reduce your risks - Mutual Funds diversify your portfolio by
investing in various securities & minimize the risk.
2) Maximize your opportunities - The fund managers with the
strong research take explore new investment options make available
opportunities for your investments to flourish.
3) Liquidity: Quick access to your money - Mutual Funds can be
bought and sold on any dealing day
4) Affordability - Of course you dont need to be millionaire to invest
in mutual fund as the minimum investment in mutual fund starts from
Rs.500/-. A Mutual Fund because of its large corpus allows even a
small investor to take the benefit of its investment strategy.
5) Low Costs - Mutual Funds are a relatively less expensive way to
invest compared to directly investing in the capital markets because
the benefits of scale in brokerage, custodial and other fees translate
into lower costs for investors.
6) Tax Benefits - The tax benefits that Mutual Funds investors enjoy
at the moment is the treatment of long-term capital gains.
Investors have two options as regards long-term capital gains:

Tax @ 10% on capital gains without indexation (plus surcharge)

Tax @ 20% on capital gains after indexation (plus surcharge)

7) Transparency - The investor gets regular information on the value


of his investment in addition to disclosure on the specific investments
made by the fund, the proportion invested in each class of assets and
the fund manager's investment strategy and outlook.
8) Regulated for investor protection - All Mutual Funds in India are
registered with the regulator of the Indian securities industry - the
Securities and Exchange Board of India (SEBI). The funds function
within the framework of regulations designed by SEBI and these
regulations are intended to protect the interests of investors. The
operations of the mutual funds are also regularly monitored by SEBI.

BIBLIOGRAPHY
TEXT:
Fischer, Donald E, Ronald J Jordan; Securities analysis and
portfolio management; Fifth edition :Prentice hall of India.
Bhalla,

VK,

SK

Tutija;

security

analysis

and

portfolio

management, Second edition;S chandr and company limited.


Sharpe, William F; investments; first edition printers hall
international
NEWSPAPERS
Nikhil lohade,There is something tricky about mutual fund
IPOs article business standard.
The Economic times
WEBSITES
www. Personalfn.com
http://www.bondmarkets.com
www.icicibank.com
www.in.taxes.yahoo.com
www.economictimes.indiatimes.com
www.Rbiindia.com
www.worldbank.com
RBI Notifications
Finance Bill

www.sebiindia.com

ANNEXURE
Questionnaire
Data on Interest rates

QUESTIONNAIRE
:

1. Occupation

Business

[ ]

Salaried

2. Name of securities purchased in the following format

Name of security

FY 2003-04
(Please tick)

ICICI Infrastructure Bonds


RBI Relief Bonds
IDBI Bonds
Fixed Deposits

FY 2002-03

National Saving Certificates


Provident Fund
LIC
others, specify
3. Are you aware of the interest rate changes?
Yes / No

4. Weightage of factors which effect decision of investments in securities

Please assign marks to these factors according to your preference so that the
total doesnt exceed 10

Factors

Interest Rates
Tax Benefits
Risks Attached
Liquidity
Others specify

5. Rate your awareness at the time of investment

Factors
Low

Changes in interest rates


Tax Benefits
Risks Attached

High

Medium

Liquidity
Others, Specify

6. Where do you gather information from?

Scale

3 - Most Important source


1 - Least Important source

Sources

Agents
Mutual fund companies
Friends
Colleagues

Media/Advertisement
Family Members
Others, Specify

7. Do you find capital market more attractive in view of recent fall in interest
rates of investment?

Yes/No

8. In view of fall in interest in rates, would you like to make lesser


investment in the same investment option as compared to last year

Yes / No / cant say

If yes then will you

(A)

Spend more on Consumable items; or

(B)

Invest in capital market

DATA ON INTEREST RATES


Min

2-3

3-5

over 5

15-30

30-45

46-90

91-180 181-1

1-1.5 1.5-2

5.50

6.5

7.5

8.5

8.5

10

10

8.25

8.75

8.75

9.75

9.75

Bank of Baroda -

5.5

6.5

7.5

9.5

10

10

Bank of India

5.50

6.25

6.75

7.25

8.5

8.5

10

10

5.25

5.25

7.5

9.5

10.5

10.75

5.25

5.25

6.25

6.75

7.25

8.5

8.5

10

10

4.5

6.25

6.75

7.5

8.5

8.5

10

10

Corp. Bank

6.25

6.25

6.5

7.25

9.25 9.25

9.25

10.25 10.25

Dena Bank

5.5

6.25

6.75

7.5

8.5

10

10

5.5

8.25

9.25

9.75

10.5 10.75 10.75 11

11

Inv.
Allahabad
Bank
Am. Express

Bank

of

Maharashtra
Canara Bank
Central Bank of
India

Global
Bank

Trust 10,00
0

8.5

years years years

HDFC Bank

25,00

7.75

8.5

9.5

7.5

8.25

8.5

9.25

10.25 10.25 10.25 10.25 10.25

5.5

7.5

7.75

8.75

9.5

10.25 10.25 10.25 10.25

6.5

6.5

7.5

8.5

Indian Bank

6.75

9.25 9.25

J&K Bank

5.5

5.5

8.5

9.5

10

6.5

7.25

6.5

1,000 5

HSBC Bank

ICICI Bank

IDBI Bank
Indian
Overseas Bank

10,00
0
10,00
0

Bank
UCO Bank
Union Bank Of
India
UTI Bank

75

10

10

9.25

9.25

9.25

10

10

9.5

10

10

10.25 10.25 10.5

10.5

10.5

9.5

10

10

6.5

8.5

8.5

10

10

6.25

6.25

8.5

8.5

10

10

7.5

8.75 8.75

9.25

9.75

9.75

5.5

5.5

6.5

10

10

1,000 5.5

5.5

6.75

7.5

7.5

8.5

8.5

10

10

8.5

9.75

10.75 10.75 10.75 10.75 10.75

National Bank

Syndicate

8.5/8.

10

10

Punjab

India

7.5/7.7

10

Oriental Bank

State Bank Of

7.75

8.5