KPB HINDUJA COLLEGE OF COMMERCE

315, NEW CHARNI ROAD, MUMBAI -400004.

PROJECT REPORT ON
Fixed Income Securities

UNIVERSITY OF MUMBAI
FOR ACADEMIC YEAR
2016-2017

PROJECT GUIDE
MRS. Mrunalini Shringare

PREPARED AND SUBMITTED BY

Rushabh Rasik Chheda
T.Y.BIM (SEMESTER – VI)
ROLL NO - 03

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 CERTIFICATE

This is to certify that Mr. Rushabh Chheda of B.com

(Investment Management) Semester 6 [2016-2017] has
successfully completed the Project on “Fixed Income
Securities” under the guidance of Mrs. Mrunalini Shringare

________________ ________________
Project Guide Co-ordinator

________________ ________________
Internal Examiner External Examiner

________________ ________________
Principal College Seal

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 DECLARATION

To,
The Principal,
K.P.B. Hinduja College of Commerce,
315, New Charni Road,
Mumbai - 400 004.

Respected Madam,

I, the undersigned hereby declare that the project report entitled

“Fixed Income Securities” is an original work developed and
submitted by me under the guidance of Mrs. Mrunalini Shringare .
The empirical findings in this report are not copied from any report
and are true and best of my knowledge.

DATE:
PLACE: MUMBAI
ROLL NO: 03
SEAT NO:

Signature of Student

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 Index
Sr no. Particulars Page No.
1. Introduction
1.1 Introduction 5
1.2 Objective of the Study 7
1.3 Methodology 7
1.4 REVIEW OF LITERATURE 7-8
1.5 Significance of the Study 8
1.6 Chapter scheme 8-9
1.7 Limitation of the study 9
2 Review of Literature 10
3 Conceptual framework 12
4 Fixed Deposits 14
5 National Saving Certificate 20
6 Post office monthly income 28
Scheme
7 Bonds 34
8 Public provident fund 41
9 Advantages and Disadvantage 49
10 Types of Risk 53

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11 Conclusion 59
12 Biblography 60

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 Chapter 1
Introduction

1.1. Introduction
This project is entitled as “FIXED INCOME” as the name suggests, is
an investment avenue wherein the investor gets predictable returns at
set intervals of time. This investment class is relatively safe with low
volatility and forms an ideal investment option for people looking at
fixed returns with low default risk, e.g., retired individuals. Fixed
income securities denote debt of the issuer, i.e., they are an
acknowledgment or promissory note of money received by the issuer
from the investor.
When one buys a fixed income instrument, one is essentially lending
money to a borrower. Money does not come free so one would expect
something in return from the borrower. The borrower issues out
interest payments which could be paid either annually, quarterly,
monthly or any other frequency that is pre-decided. These interest
payments are called interest/coupons. Since such interest/coupons are
fixed in nature, these instruments are called fixed income instruments.
The borrower also promises to return the money he borrowed. So,
apart from a consistent income in the form of coupons, one also gets
principal back. Such products are available for different maturities
and credit ratings. They are available in India through government
schemes, company bonds and fixed deposits.
An example of a fixed-income security would be a 8% fixed-rate
government bond where Rs. 1,000 invested would result in an annual
Rs. 50 payment until maturity when the investor would receive the
Rs. 1,000 back.
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Investors Behaviour Towards Fixed Income Securities. Generally,
these types of assets offer a lower return on investment because they
guarantee income. Putting all the money into equities can give more
returns but it does carry high risk as well. Diversification is a basic
concept of financial planning and fixed income products come in
handy to help achieve this objective.

1.2. Objective of the Study -

1. To understand the fixed income avenues.
2. To know the future value of investment.
3. To analyse the Investment on basis of safety, liquidity and
returns.
4. To study investors behaviour pertaining to Fixed Income
Securities.

1.3. Methodology
This project is concerned only with secondary data viz. books,
references, database, journals and statistical record, report and
websites.

1.4. REVIEW OF LITERATURE

1. Das Kanti Sanjay (2012) studied the middleclass household’s
investment behaviour and found that the trends of investment by
households are not similar in nature and they vary between
several financial instruments. The study reveals that amongst
other avenues the bank deposits remain the most popular
instrument of investment followed by insurance and small saving

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 scheme with maximum number of respondents investing in fixed
income bearing option.

2. Chaturvedi Meenakshi & Khare Shruti (2012) studied the Saving

Pattern and Investment Preferences of Individual Household in
India found out that most investors preferred Bank Deposit as the
first choice of investment and next to bank deposits small saving
schemes constitutes the second choice of investment.

1.5. Significance of the Study

Investment is the most important thing today. Business men’s are
earning handsomely. They have all right to invest and spend to some
extent. But lack of financial education, put them in much more
difficult situation. At present lot of investment avenues are available.
While making the choice, they should also consider the rate of return
and risk on their investment. Fixed income securities, or bonds, play
a vital role in a well diversified portfolio. They are defensive in nature
and provide capital stability, income, liquidity and diversification to
other growth-oriented asset classes such as equities and property.

1.6 Chapter scheme

This project consist of following chapters:
Chapter I: Introduction
Chapter II: Review Of Literature
Chapter III: Conceptual framework

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Chapter IV: Fixed Deposit
Chapter V: National Saving Certificate
Chapter VI: Post Office Monthly Income Scheme
Chapter VII: Bond
Chapter VIII: Public Provident Funds
Chapter IX: Advantages And Disadvantages
Chapter X: Types Of Risk

1.7 Limitation of the study

1. The project consists of Fixed Income Securities.
2. Due to time constraint primary data is collected.
3. The project is based on secondary data.
4. The study is limited to basics of fixed income securities.
5. The global fixed income securities are not covered.
6. Risk attached are covered.

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 Chapter 2
Review of Literature
2.1. Introduction
o Review of literature is one of the most important steps in the
research process.
o The main purpose of literature review is to convey to the readers
about the work already done and the knowledge and idea that
have been already established on a particular topic of research.
o A literature review is an evaluative report of information found
in literatue related to selected area of the study.

2.2. Review
1. Das Kanti Sanjay (2012) studied the middleclass household’s
investment behaviour and found that the trends of investment by
households are not similar in nature and they vary between
several financial instruments. The study reveals that amongst
other avenues the bank deposits remain the most popular
instrument of investment followed by insurance and small
saving scheme with maximum number of respondents investing
in fixed income bearing option.

2. Chaturvedi Meenakshi & Khare Shruti (2012) studied the

Saving Pattern and Investment Preferences of Individual
Household in India found out that most investors preferred Bank
Deposit as the first choice of investment and next to bank
deposits small saving schemes constitutes the second choice of
investment.

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3. Geetha N, & Ramesh M. (2012) studied the Relevance of
demographic Factors in Investment Decision and reveals that
there is significant relationship between the demographic factors
such as gender, age, education, occupation, annual income and
annual savings with the sources of awareness obtained by the
investors.

4. Gupta L.C. & Jain (2008) in their article “The Changing

Investment Preferences of Indian Households” survey 2008,
conducted by society for capital market research and
development, new Delhi pointed out that ‘too much volatility’,
‘too much price manipulation’, ‘unfair practices of brokers’ and
‘corporate mismanagement and frauds’ as the main worries of
investors.

5. Krishna Moorthi C. (2009) is his research paper “Changing

Pattern of Indian Households: Saving in Financial Assets”
published in RVS Journal of management, 2009 concluded that
irrespective of the developments in the capital market/economic
conditions, investors like to invest regularly and this investment
behaviouris highly related to educational background. Their
occupation, reading habit of investment news and the time taken
for investment decision making process.

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 Chapter 3
Conceptual Framework
1. Fixed Income: Fixed income refers to any type of investment
under which the borrower/issuer is obliged to make payments of
a fixed amount on a fixed schedule.
2. Fixed Deposit: A fixed deposit (FD) is a financial instrument
provided by banks which provides investors with a higher rate
of interest than a regular savings account, until the given
maturity date.
3. Interest: It is the price paid for the use of borrowed money.
4. Tax: A compulsory contribution to state revenue, levied by the
government on workers' income and business profits, or added
to the cost of some goods, services, and transactions.
5. Future Value: It measures the nominal future sum of money that
a given sum of money is "worth" at a specified time in the future
assuming a certain interest rate.
6. Indemnity: An indemnity is a sum paid by party A to party B by
way of compensation for a particular loss suffered by B.
7. Maturity: In finance, maturity or maturity date refers to the final
payment date of a loan or other financial instrument, at which
point the principal (and all remaining interest) is due to be paid.
8. Compounding: The ability of an asset to generate earnings,
which are then reinvested in order to generate their own
earnings.
9. Debt: A debt is an obligation owed by one party (the debtor) to a
second party.
10. Asset: Anything tangible or intangible that is capable of
being owned or controlled to produce value and that is held to
have positive economic value is considered an asset.
11. Inflation: a sustained increase in the general price level of
goods and services in an economy over a period of time.
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12. Installments: a sum of money due as one of several equal
payments for something, spread over an agreed period of time.
13. Financial instrument: a tradable asset of any kind; either
cash, evidence of an ownership interest in an entity, or a
contractual right to receive or deliver cash or another financial
instrument.
14. Volatility: A measure for variation of price of a financial
instrument over time.

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 Chapter 4
Fixed Deposit
4.1 Introduction
Most Indians who earn a steady income would have invested in fixed
deposits at some time or other. Without doubt, it is one of the safest
and simplest investment options available. It is one of the oldest and
most popular forms of investment across India

4.2 Concept of Fixed Deposit

In case of fixed deposits, one deposits a lump sum of money (called
principal) in the bank at a certain rate of interest for a fixed period of
time. The bank returns the principal along with interest earned, either
at the end or at regular intervals. The interest rate and tenure is
specified at the time of opening the FD. The interest rate remains
constant throughout the tenure of the FD irrespective of the
movement in market interest rates. Fixed deposits are known as term
deposits or time deposits also. Fixed deposit a/c allows one to deposit
its money for a set period of time, thereby earning a higher rate of
interest in return. At the end of maturity period the depositor gets its
principal amount plus interest earned over the maturity period. FDs
also give a higher rate of interest than a savings bank account.

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4.3 Components
1. Principal amount – the amount which one deposits with the
bank.
1. 2. Compounding method (used by the banks to provide interest
payment. -Annually -Semi-annually -Quarterly -
Monthly
2. Duration of the fixed deposit. (7Days-10Years & above)
3. Interest rate paid on the deposit. (6%-11% in India)
4. Penalty clause.

4.4 Tax Deduction

Banks deduct tax at source on interest paid in excess of Rs. 10000 per
annum to any depositor. This is not per deposit but per individual.
You are eligible for tax deduction if the term of investment is more
than 5 years.

4.5 Compounding of Interest on Fixed Deposits

(Cumulative)
Compound interest arises when interest is added to the principal so
that from that moment on, the interest that has been added also itself
earns interest. This addition of interest to the principal is called
compounding. The following formula gives the total amount one will
get if compounding is done:-

A= P ( 1 + r/n) nt
Where, A = Final Amount that will be received

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P = Principal Amount (i.e. initial investment)
r = Annual nominal interest rate (as a decimal i.e. if interest is paid
at 5.5% pa, then it will be 0.055) (it should not be in percentage)
n = Number of times the interest is compounded per year (i.e. for
monthly compounding n will be 12, for half year compounding it will
be 2 and for quarter it will be 4)
t = Number of years

4.6 Illustration
An amount of Rs.10000 is deposited in a bank paying an annual
interest rate of 9%, compounded quarterly. Find the balance after 10
years.
A. Using the formula above, with P = 10000, r = 9/100 = 0.09, n = 4
and t = 10:
A= 10000(1 + 0.09/4) ^ (4*10) = 24,351.8896 So, the balance after 10
years is approximately Rs. 24,532.

4.7 Benefits of Fixed Deposit

1. Safety - FDs have conventionally been the premier choice for
investors with a low risk appetite; assured returns is the key factor
which attracts investors towards deposits.
2. Regular Income - Fixed deposits earn fixed interest rates for their
entire tenure, which is usually compounded quarterly.

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3. Saves Tax - investment in fixed deposits up to a maximum of
Rs.100, 000 for 5 years are eligible for tax deductions under section
80 C.

4.8 Downsides of FD’s

1. Liquidity– FD’s are not so liquid i.e. it cannot be withdrawn before
it expires. One can check your FD fares on the pre-mature
encashment front i.e. how easily can one’s investment be liquidated.
And the penalty clauses, e.g. do you suffer a loss of interest and/or
principal amount. Interest earned after FD maturity is taxable.

4.9 Procedure for investing in Fixed Deposit

Schemes
1. One can open a fixed deposit with any national, private or foreign
bank.
2. One will have to submit Know Your Customer (KYC) documents
like photograph, proof of identity (PAN card) and address proof.
3. If one has an online account with a bank, one may even have the
option of opening FD online.
4. Deposits can start as low as Rs. 100 but varies from bank to bank.

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4.10 Important Article in Newspaper on FD
Dated On November 17,2016

Bad news for FD investors: SBI, Kotak HDFC slash deposit rates
Fixed deposit investors, beware. Government's decision to replace Rs.
500 and Rs. 1,000 notes them with new currency notes may spell bad
news for FD investors

Fixed deposit investors, beware. The government's decision to abolish

Rs. 500 and Rs. 1,000 notes and replace them with new currency
notes to crack down on black money may spell bad news for fixed
deposit investors.

With crores of cash pouring into banks everyday, some banks have
sought to cut deposit rates. Banks need to reduce their deposit rates in
order to pass on the benefits of Reserve Bank of India rate cuts,
amounting to 175 bps since January 2015, to borrowers. So while
borrowers can avail cheaper loans, fixed deposits will turn
unattractive.

The high-value notes made up Rs 14.1 lakh crore of the cash in

circulation. If a substantial portion of that comes back to the banks,
there will be a massive spike in deposit base.This will bring down the
cost of funds for banks. The lenders are trying to figure out where to
put the cash. Therefore, the deposits are being invested in bonds,
leading to a spike in the prices of the papers.

How this works:

The demonetisation of big currency notes will lead to more money
being deposited in savings and current accounts of
commercial banks. Higher bank deposits will put downward pressure
on bank fixed deposit rates as credit growth in the economy is yet to
pick up. Corporate FDs may give higher returns, but risks are attached
to it.

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For the watchful investor, here are some banks that have already
slashed interest rates on Fixed Deposits:

State Bank of India

SBI slashed the interest rate on its fixed deposits (FDs) on select
maturities by up to 0.15 per cent. Term deposit of 1 year to 455 days
has been reduced by 0.15 per cent to 6.90 per cent from 7.05 per cent
effective on Thursday. Its 5-year interest rate on FDs is 130 bps lower
than the 5-year post office term deposit rate. The interest rate
difference between the small savings products and bank FDs has been
steadily increasing. Besides, the one of 456 days to less than 2 years
also gets cheaper to 6.95 per cent from 7.10 per cent. The interest rate
on 1-year FD is now at 7.05%, compared to 7.15% earlier. The
proposed rates of interest shall be made applicable to fresh deposits
and renewals of maturing deposits. SBI’s rate cut is an indicator that
the deposit and lending rates are set to fall further in the banking
industry.

Kotak Mahindra Bank

Private-sector lender Kotak Mahindra Bank has reduced the interest

rate on one-year fixed deposits (FDs) by 25 basis points (bps) to 7%,
lower than 7.05% offered by the State Bank of India (SBI) on deposits
of the same tenure. The new rate came into effect on Monday. Kotak
has also reduced rates on two- and three-year deposits by 50 bps each
to 6.75%.

4.11 Conclusion

Due to lack of research it is found that though many are not

interested in playing the investment game, there is hesitance to do so
with confidence because of lack of information and risk taking
attitude.

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 Chapter 5
National Savings Certificate

5.1 Introduction
National Savings Certificate (NSC) is a popular fixed income earning
instruments which can be opened with a Post Office and also help in
saving tax under Section 80C. The Scheme is specially designed for
Government employees, businessmen and other salaried classes who
are Income Tax assesses.

5.2 Concept
The government of India started the National Savings Certificates
Scheme to encourage the habit of saving among Indians and to use the
funds collected for developmental activities. The combination of a
good rate of return, safety and tax benefits have made National
Savings Certificated hugely successful. The interest rate offered is
subject to review from time to time. But the good news is that once
invested in NSC’s, at a particular interest rate, it stays the same
throughout the duration of that certificate. For example, if one
invested in 5 year NSC’s in December 2011, one would have earned
an interest of 8.4 %( compounded half yearly). This rate of interest
remains constant for that certificate till its maturity-whether interest
rate of NSC’s goes up or down during the 5 years. Does that make a
difference? It does, because one is sure about the amount one will
receive on maturity. If one invests Rs 100 at 8.4%, at the end of 5
years, one will receive Rs 150.90 when one redeems itsNSC

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certificate. So even if interest rates offered the next year may reduce,
maturity amount will not be affected.
Till December 1, 2011, the maturity periods of NSC’s were 6 years.
The Government reduced this period for 5 years, while at the same
time they increased the interest rates from 8% to 8.4%. Further, it was
also announced that the rates of NSC’s issued each year will be
announced before the beginning of every financial year (April1). The
rates for financial year 20122013 had accordingly been announced on
March 26, 2012. The interest rates offered for NSC’s bought in its
financial year (between April 1 2012 and March 31, 2013) will be
8.6% instead of 8.4%. So instead of Rs150.90 one will receive
Rs152.35 on maturity for every Rs 100 invested in NSC’s during that
financial year. Interest is calculated every 6 months (compounded half
yearly) so one ends up with an effective return that is higher than the
annual rate quoted. For example if an 8.4% interest is being offered ,
the effective interest rate works out to 8.58% p.a. in an financial year,
investments of up to Rs 1,50,000 in NSC’s qualify for income tax
benefits under section 80c.
In addition to 5- year NSC’s, from December1, 2011, the government
has also launched 10-year NSCs. This is similar to 5-year NSCs,
except that the maturity period is 10 years and the interest offered is
currently higher than the 5-year maturity NSC. For financial year
2012-2013, the interest rate announced for 10-year NSCs Is 8.9%. So
for every Rs. 100 you invest, one will receive Rs. 238.87 at the end of
10 years.

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5.3 Currents interest rates
Interest rates 2015- Q1 and Q2 Q3 and Q4
16
8.5 8.1 8.0

5.4 Minimum and Maximum Amount

The Minimum Amount to be invested in National Savings Certificate
is Rs. 100 and there is no maximum limit on the amount to be
invested in the NSC. A person can invest any amount in National
Savings Certificate. However, tax deduction u/s 80C can only be
claimed for a maximum of Rs. 1, 00,000. The National Savings
Certificate is issued in denominations of Rs. 100, Rs. 500, Rs. 1000,
Rs. 5000, and Rs. 10,000. A person can purchase any no. of
certificates of any denomination.NRI’s are not eligible to purchase
National Savings Certificate (NSC). However, if a person was a
Resident Indian at the time of purchasing the NSC and become a NRI
during the maturity period, he shall be allowed to claim benefits of
this scheme.HUF’s and Trusts are also not eligible to invest in this
savings scheme.

5.5 Example NSC

To understand this reinvestment business, let’s take the example of an
investment of Rs. 10,000 in NSC Issue IX. Being part of Issue IX, the
maturity period will be 10 years and the interest rate will be 8.8% per
annum (as of Jan 2016). In the first year you will earn Rs. 880 as
interest and you will declare Rs. 10,000 as investments in NSC under
section 80C. In the second year the Rs. 880 that you earned will be
added to the original investment brining the invested amount to Rs.
10,880 which will earn interest at 8.8% for the next year.

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 At this point, if you don’t purchase any more certificates then you will
declare the interest earned as income from other sources while
computing your tax for year 2. At the same time you will also declare
that amount as investment in NSC under 80C in NSC, which means
the two shall cancel each other out and your interest will be tax free.
Let’s assume that in the 3rd year you purchase additional certificates
worth Rs. 20,000 so while filing your taxes, you will declare the
interest earned from the previous amount as income and investment
and you will also declare Rs. 20,000 as investment in NSC.
It is only in the last year that any income tax will be payable since the
interest that you earn in the year will not be reinvested in NSC but
will be paid out to you. In this case, you will declare the interest
earned in the last year as income from other sources and that will be
it. Since there is no TDS with NSC, you will be paid the entire
maturity value of the certificates and the payment of applicable taxes
will be your responsibility.

5.6 Types of NSC certificates

There are two types of NSC certificates that are available at the post
office. While the two types, referred to as Issues, share the same
general properties, there are some subtle differences between the two.
 NSC Issue VIII
With NSC Issue VIII, the aim was to provide an investment avenue
for those people who were looking for a way to invest in safe
instruments and avail tax benefits at the same time. The certificates
issued under this version are available to everyone except an HUF
and a trust. These certificates come in denominations ranging from
Rs. 100 to Rs. 10,000 but have an interest rate that is slightly lower
than the once offered for Issue IX. Another key feature of these
certificates is that they come with a maturity period of 5 years.
 NSC Issue IX
The Issue IX certificates also come in denominations ranging from
Rs. 100 to Rs. 10,000 and comes with an interest that is slightly
higher than that which is offered for Issue VIII. These certificates
come with a maturity period that can be as long as 10 years. As is
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 the case with Issue VIII, these certificates also comes with no limit
on the amount that can be invested in them but there is a limit on the
minimum investment, which is Rs. 100.

5.7 Nomination Facility

The purchaser of the National Savings Certificate (NSC) may
nominate any person as a nominee at the time of purchasing the
National Savings Certificate in Form 1 or before the maturity of the
NSC in Form 2. The person so nominated shall be entitled to claim
the maturity proceeds in case of death of the Original Holder.
In the event of death of the holder of certificate, the nominee(s) shall
be entitled at any time before or after the maturity of the certificate
to:-
1. Encash the Certificate.
2. Sub-divide the NSC Certificate in appropriate denominations in
favour of individual nominees.
However, the rights of the nominee would only come in force in the
event of death of the original holder of the National Savings
Certificate (NSC). The nominees would also be required to make an
application to the Postmaster intimating him about the death of the
original holder. This application should also be accompanied with the
Death Certificate.

5.8 Duplicate NSC certificates

It is an unfortunate situation but there can be an instance where the
certificates that you got, as a result of an investment in NSC, which
were destroyed or lost. If you ever hope to encash them, you are going
to need duplicates and to get them you will have to know the
following:
 If you have lost your certificates, or if they have been rendered
useless as a result of defacing or destruction or even theft, you can
apply to the post office that you got the certificates from.

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 If your post office is otherwise inaccessible, you can submit the
application for duplicate certificates at any post office and they will
forward it to the appropriate one.
 When you submit the application, make sure that you mention
details such as the number of the certificates, the dates on which
they were purchased and the amounts for which they were
purchased.
 You will also have to ensure that you mention the reason for the
request for duplicate certificates.
 If the value of the lost certificates is more than Rs. 500 then an
indemnity bond will be required that will have either approved
securities to back it or a guarantee from a bank.
 If the certificate being replaced is submitted as proof of destruction
or defacing of the original then no indemnity bonds or securities
will be required. This will, however, depend on the discernibility of
the authenticity of the destroyed certificates.
 Once a duplicate certificate is issued, it will be redeemable only at
the post office where it was issued.

5.9 Fee and charges

When it comes to the fees and charges associated with the issuance of
a National Saving Certificate, the amount charged is Rs. 5 and is
payable in the following scenarios:
 When the certificates are transferred from one person to another
person or an entity.
 When the postmaster issues a certificate of discharge upon
encashment of certificates.
 When a holder requests for duplicate certificates.
 When the denomination of the certificate is changed.
 When the nomination is made AFTER the certificates have been
purchased.
 When the nomination is changed.

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 5.10 Premature withdrawals
The NSC investment comes with a lock-in period that is equal to the
maturity of the certificates. They can only be withdrawn before the
maturity date if:
 The holder of the NSC passes away.
 The holder of the certificate has forfeit them through a pledge.
 A court of law has ordered that the NSC be paid prematurely.
When it comes to the amount that you will get from closing an NSC
prematurely the conditions are:
 If less than a year has passed since the certificate was purchased
then only the invested amount will be returned and not interest will
be paid.
 If the period that has elapsed since the certificates were bought is
between 1 year and 3 years then the interest payable will be simple
interest.

5.11 Benefits of National Savings Certificate

1. One can avail of income tax deductions under Section 80C for
investments up to Rs. 1.5 lakh in NSCs.
2. Investment is virtually risk-free as it is guaranteed by the
Government of India.
3. NSCs are transferable and can be encashed in any part of India.
4. Although premature withdrawals are not allowed, one can take a
loan against NSCs from a bank or any other institution.
5. NSCs are ideal for people who are not willing to take risks and are
happy with average or slightly above average returns. It is a good
medium to long-term investment product which can be used for
specific goals accumulating funds for children’s education and
marriage.
6. Investing in NSCs is easy and simple.

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5.12 Downsides of National Savings Certificate
1. It has a lock-in-period of 5 or 10 years (depending on the maturity
chosen) during which money remains unavailable.
2. NSCs are mostly available in physical form. They have to be
presented at the post office on maturity, so one need to keep them safe
during the period of investment.
3. On maturity, interest received is taxable although it is not deducted
at the time of encashment.

5.13 Procedure for Investing in NSCs

1. One can invest in NSCs at most post offices in India by filling up
an application form. One can either do it personally or through an
authorized agent. One can purchase it under their name or jointly and
even nominate someone. One can pay through cash, local cheque,
demand draft, pay order or even another NSC that has reached
maturity.
2. One will receive a physical certificate in return for the money
invested.
3. On maturity one will receive the amount due by representing their
NSCs at the post office.
5.14 Conclusion
People with positive perception might tell good things about the
schemes to other people. In fact, they might act as unpaid publicity
agents. Hence, it is necessary to study about the nature of perception
that exists among investors about saving schemes and institutions
offering such instruments.

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 CHAPTER 6
POST OFFICE MONTHLY INCOME
SCHEME

6.1 Introduction
Post Office Monthly Income Scheme plan is one of the many
investment options offered by Post Office in India, apart from
delivering mails, post office offers a bouquet of services that include
sale of forms, bill collection, savings schemes, life insurance cover
etc. Schemes offered by Post Offices are risk free as there is no touch
of equity in them. POMIS is an investment avenue that’s safe and
secure, that earns substantial returns with a short locking period that
says no to equities and is absolutely risk free.

6.2 Documents Required

1. Address Proof
2. Two passport size photographs
3. Identity Proof – This may include
4. Passport 5. PAN Card 6. Ration Card 7. Voter Identity Card issued
by the Election Commission of India

6.3 This scheme provides:

1. Monthly Income
2. Safe/ Government Backing/Risk free investment
3. Attractive Fixed Rate of Interest(8.4% p.m. currently)
4. Nomination Facility available

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6.4.Concept
Making an investment in POMIS is easy as a pie and requires
minimal documentation. The investor needs to submit a copy of the
address proof and identity proof (passport/PAN card/ration card/voter
identity card) and passport size photographs. To get started, the
investor needs to open an account. He can opt for either an individual
account or a joint account. This table below shows the minimum and
maximum amount that can be invested in POMIS.

6.5 Illustration:
Mr. Sharma chooses to make an investment in MIS. He invests Rs
1,00,000 with a maturity period of 5 years. At an annual interest rate
of 8.5%, he should get a fixed payout of Rs 708 every month (this
figure can be summed out very easily on a POMIS calculator
available online). At the end of the investment tenure, he’ll get his
deposit money back.
The money can be withdrawn in two ways, either directly from post
office or get it credited in your savings account through ECS. The
money is usually meant to be withdrawn on a monthly basis.
However, the investor can let it to accumulate over a few months and
withdraw it, then withdraw it but it’s not of much use as the idle
money will not earn you any interest.
To make POMIS more effective at yielding returns, a new feature was
added to it. The investor has the option of combining it with a
recurring deposit wherein the interest that you earn on a monthly basis
is invested in a recurring deposit. This in turn, lets your money to
grow even more money.

29 | P a g e
6.6 Features
Features Description
Eligibility Any individual singly or jointly with other one or
two adults. A guardian on behalf of minor or a
person of unsound mind. A minor who has attained
the age of 10 years.
Minimum Rs. 1,500/-
amount
Maximum Rs. 4.5 lakhs in single account and Rs. 9 lakhs in
amount joint account. Any number of accounts can be
opened subject to the maximum prescribed limit.
Maturity period period
Six years for accounts opened up to 30th November
2011. Five years for accounts opened after 1st
December 2011.
Nomination Available
facility
Interest Rates 1. W.E.F. April 1, 2016 - 7.80%

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 Prior to April 1, 2016 - 8.40%
2.
Tax benefits Not available
Interest Taxable.
Taxability

6.7 Comparison
Monthly Income Monthly Income Monthly Income
Scheme Plan(Mutual Fund) Plan (Insurance)
Meaning
A post office A debt oriented A variant of
investment scheme mutual fund in which retirement plan in
guaranteeing fixed the investment is which the annuities
monthly income at a made in equity-debt are paid to the insured
8.5% annual rate instruments in a 20:80 in form of monthly
ratio income
Security
Monthly income is Monthly income is Monthly income is
guaranteed not guaranteed. fixed and guaranteed.
Rather, it depends on It is created out of the
the returns earned for nest egg of premiums
that particular period paid throughout the
policy tenure.
Tax
TDS is not applicable. TDS is not applicable The annuity paid
However, interest monthly is taxable
earned is taxable
Types of investor
MIS suits best for MIPs are for those Retirement monthly
those who cannot risk averse investors income plans are for
afford to bear any risk who like to stay those who are looking
such as old aged and somewhere in to get the dual
retired people between the safe- benefits if insurance
butunyielding debt and investment
funds and the risky-
31 | P a g e
 butyielding equity
funds
Time Period
The locking period is The investor has to The investment tenure
just 1 year after which incur 1% exit load for is quite long (as this
the investor can cashing the units is a long term plan)
withdraw the money, within 1 year of and the insured has to
but not without investment incur surrender
incurring 12% penalty charges for
charges withdrawing the
amount before the
policy term
Amount
There’s a limit to the There’s no such limit No limit on
amount you can on investment amount investment amount
invest in POMIS (4.5 in MIPs
lakh for single
account, 9 lakh for
joint account)
Returns
The returns are fixed The returns are not The motive of
at 8.5% fixed. They can shoot monthly income plans
up to 14% at times or is to get insured and
tumble down even secure the capital,
negatively. rather than getting the
return

6.8 Benefits of POMIS

1. POMIS is guaranteed by the Government of India and is therefore
100%safe.
2. There is minimal penalty on premature closure.
3. One can open multiple accounts, which can add up to Rs 4.5 lakh
per individual. One can also open a POMIS account any minor aged
10 years or above. 4. Interest is not taxable at source.
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6.9 Downsides of POMIS
1. The lock-in period is 5 years
2. One can close its account prematurely only after 1 year of opening
the account.
3. POMIS cannot be operated online. One has to open a savings
account in the same post office to get interest automatically credited.

6.10 Procedure for Investing in POMIS

1. One can open a POMIS account at any post office in India.
2. Anyone who is 10 years old or above can open an account in their
individual name.
3. On successful opening of the account, one will receive a certificate
mentioning your investment amount, your monthly income amount,
and the maturity date. You’ll also receive a passbook to record your
monthly payments.

Investment Amount
Lower cap Upper cap
Single Account 1,500 4,50,000
Joint Account 1,500 9,00,000

6.11 Conclusion
Still in villages people invest in POMIS and in urban areas many
housewives also invest in POMIS they invest the part of saving so
POMIS are very famous investment after FDs.

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 Chapter 7
Bonds
7.1 Introduction
The Bond Market in India with the liberalization has been
transformed completely. The opening up of the financial market at
present has influenced several foreign investors holding up to 30% of
the financial in form of fixed income to invest in the bond market in
India. The bond market in India has diversified to a large extent and
that is a huge contributor to the stable growth of the economy. The
bond market has immense potential in raising funds to support the
infrastructural development undertaken by the government and
expansion plans of the companies.

Sometimes the unavailability of funds becomes one of the major

problems for the large organization. The bond market in India plays
an important role in fund raising for developmental ventures. Bonds
are issued and sold to the public for funds. Bonds are interest bearing
debt certificates. Bonds under the bond market in India may be issued
by the large private organizations and Government Company. The
bond market in India has huge opportunities for the market is still
quite shallow. The equity market is more popular than the bond
market in India. At present the bond market has emerged into an
important financial sector.

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7.2 Concept
A bond is a type of debt. It’s a loan from an investor to an institution,
and in exchange the investor collects predetermined interest rates.
Whenacompany needs capital to expand its business, it issues bonds
to the public. Investors buy them with the understanding that they will
collect the original principal plus interest when the bond matures at a
set date.

7.3 Major types of bond market

1. Corporate Bond Market(Debentures)
2. Government Bond Market

7.4 Features
7.4.1 Principal
Nominal, principal, par or face amount is the amount on which the
issuer pays interest, and which, most commonly, has to be repaid at
the end of the term. Some structured bonds can have a redemption
amount which is different from the face amount and can be linked to
performance of particular assets such as a stock or commodity index,
foreign exchange rate or a fund. This can result in an investor
receiving less or more than his original investment at maturity.
7.4.2 Maturity
The issuer has to repay the nominal amount on the maturity date. As
long as all due payments have been made, the issuer has no further
obligations to the bond holders after the maturity date. The length of
time until the maturity date is often referred to as the term or tenure or

35 | P a g e
maturity of a bond. The maturity can be any length of time, although
debt securities with a term of less than one year are generally
designated money market instruments rather than bonds.

7.4.3 Coupon
The coupon is the interest rate that the issuer pays to the holder.
Usually this rate is fixed throughout the life of the bond. It can also
vary with a money market index, such as MIBOR, or it can be even
more exotic. The name "coupon" arose because in the past, paper
bond certificates were issued which coupons had attached to them,
one for each interest payment. On the due dates the bondholder would
hand in the coupon to a bank in exchange for the interest payment.
Interest can be paid at different frequencies: generally semi-annual,
i.e. every 6 months, or annual.
7.4.4 Yield
The yield is the rate of return received from investing in the bond. It
usually refers either to-
The current yield, which is simply the annual interest payment
divided by the current market price of the bond or to; The yield to
maturity or redemption yield, which is a more useful measure of the
return of the bond, taking into account the current market price, and
the amount and timing of all remaining coupon payments and of the
repayment due on maturity. It is equivalent to the internal rate of
return of a bond.

7.5Credit Quality
The "quality" of the issue refers to the probability that the
bondholders will receive the amounts promised at the due dates. This
36 | P a g e
will depend on a wide range of factors. High-yield bonds are bonds
that are rated below investment grade by the credit rating agencies. As
these bonds are more risky than investment grade bonds, investors
expect to earn a higher yield. These bonds are also called junk bonds.

7.6 Market Price

The market price of a trade able bond will be influenced amongst
other things by the amounts, currency and timing of the interest
payments and capital repayment due, the quality of the bond, and the
available redemption yield of other comparable bonds which can be
traded in the markets.
The issue price at which investors buy the bonds when they are first
issued will typically be approximately equal to the nominal amount.
The market price of the bond will vary over its life: it may trade at a
premium (above par, usually because market interest rates have fallen
since issue), or at a discount (price below par, if market rates have
risen or there is a high probability of default on the bond).

7.7 Subtypes
1. Fixed rate bonds have a coupon that remains constant throughout
the life of the bond.
2. Floating rate bonds have a variable coupon that is linked to a
reference rate of interest, such as MIBOR. For example the coupon
may be defined as MIBOR + 0.20%. The coupon rate is recalculated
periodically, typically every one or three months.
3. Zero-coupon bonds pay no regular interest. They are issued at a
substantial discount to par value; so that the interest is effectively

37 | P a g e
rolled up to maturity .The bondholder receives the full principal
amount on the redemption date.
4. High-yield bonds (junk bonds) are bonds that are rated below
investment grade by the credit rating agencies. As these bonds are
more risky than investment grade bonds, investors expect to earn a
higher yield.
5. Convertible bonds let a bondholder exchange a bond to a number of
shares of the issuer's common stock. These are known as hybrid
investments, because they combine equity and debt features.

7.8 Benefits of Bonds

1. Diversification - Bonds tend to be less volatile than stocks and can
therefore stabilize the value of your portfolio during times when the
stock market struggles.
2. Stability - If investors know they will need access to large sums of
money in the near future-for example, to pay for college, a home,
etc.then it does not make sense to place that money in a highly
volatile investment like stocks. Because the majority of the return on
bonds comes from the interest payments(the coupon payments),
fluctuations in the price of a bond will have little impact on the value
of the investment.
3. Consistent Income - Unlike stock dividends, coupon payments are
consistently distributed at regular intervals. Individuals seeking this
consistent income might find bonds a better alternative than the
dividend payments some stocks offer.
4. Taxes - Payments from some bonds are exempt from taxes. For
individuals in high tax brackets, these investments are often an
excellent vehicle for their portfolio.

38 | P a g e
7.9 Downsides of Bonds
1. Interest rate risk - Bond prices are inversely related to interest rates,
so if interest rates increase, the price of the bond will decrease. The
interest rate on a bond is set at the time it is issued. Generally, the
coupon will reflect interest rates at the time of issuance. However, if
interest rates increase, people will be unwilling to purchase the bonds
in the secondary market at the earlier rate. For example, if the coupon
is set at 6% and interest rates in the market are at 7%, the interest rate
on the bond is well below what you could get from a different
investment. Therefore, the price of the bond will decrease so that the
capital appreciation will make up for the difference in interest rates.
2. Credit Risk - Just as individuals occasionally default on their loans
or mortgages,some organizations that issue bonds occasionally default
on their obligations. If this is the case, the remaining value of your
investment can be lost. Bonds issued by the government, for the most
part, are immune from default. Bonds issued by corporations are more
likely to be defaulted on – companies often go bankrupt.
Municipalities occasionally default as well, although it is much less
common. One is compensated for taking on the higher risks
associated with corporate bonds. Theyield on corporate bonds is
higher than that of municipal bonds, which is higher than that of
treasury bonds. Moreover, there is a rating system that enables you to
know the amount of risk each class of bond entails.
3. Call Risk - Some bonds can be called by the company that issued
them. That means the bonds have to be redeemed by the bond holder,
usually so that the issuer can issue new bonds at a lower interest rate.

39 | P a g e
This forces you to reinvest the principal sooner than expected, usually
at a lower interest rate. This subject will be further discussed in later
sections.
4. Inflation Risk - With few exceptions, the interest rate on your bond
is set when it is issued, as is the principal that will be returned at
maturity.

7.10 Conclusion
Bonds vary according to characteristics such as the type of issuer,
priority, coupon rate, and redemption features.
Bond prices may be either dirty or clean, depending on when the
last coupon payment was made and how much interest has been
accrued.
Yield is a measure of the income an investor receives if he or she
holds a bond until maturity; required yield is the minimum income a
bond must offer in order to attract investors.

40 | P a g e
 Chapter 8
Public Provident Fund

8.1 Introduction
The key to wealth creation lies in the practice of saving regularly and
systematically. The public provident fund (PPF) is one such long-term
investment option that would suit investors of all types. Scoring high
on safety, by virtue of it being government backed, this wonderful
option comes with tax benefits, loan options and a low maintenance
cost.
Public provident fund or the commonly known as PPF is long-term
saving instrument established by the central government with an
objective of providing the old-age income security to the self-
employed.The scheme was launched by the central government in
July 1968 and is fully backed by the government therefore considered
as the safest investment option among the people. Tax deduction on
deposits, guaranteed return and tax-free maturity are the biggest
driving force which pulls the investor towards it.

8.2 Concept
It matures after the expiry of 15 years from the end of financial year
in which the account was opened or to make it more clear if the
account is opened in the FY 2004-05, then it will get mature on 01
April 21.PPF account can be opened with the minimum investment of
Rs 500 per annum and a maximum of 12 deposits allowed in a year
with an upper cap of Rs 1 lakh per annum. Investment can be made

41 | P a g e
either in lump sum or in installments but not more than 12
installments in a year or 2 installments in a month.
The PPF account can be opened by any individual or a minor through
guardian but the deposit of the minor account will get clubbed with
the account of the guardian for the maximum limit of Rs 1.5 lakh and
only one account is permissible i.e. 2 accounts at different places in
India are not permitted. We do have an option of extending the PPF
account on maturity for any period in a block of 5 years on each time
i.e. if PPF account is getting matured on April 2013 and you want to
get it extended for another 2 block then it will be extended for another
10 years.
Premature of PPF account is not allowed except in case of death
however partial withdrawals are allowed after the completion of 6
years or from the 7th financial year, we can withdraw 50% of the
balance at the end of 4th preceding year or the year immediately
preceding the year of withdrawal, whichever is lower, less the amount
of loan if any.

8.3 Features
The public provident fund is established by the central government.
One can voluntarily open an account with any nationalized bank,
selected authorized private bank or post office. The account can be
opened in the name of individuals including minor.
The minimum amount is Rs.500 which can be deposited. The rate of
interest at present is 8.7% per annum, which is also tax-free. The
entire balance can be withdrawn on maturity. Interest received is tax
free. The maximum amount which can be deposited every year is Rs.
1, 50,000 in an account. The interest earned on the PPF subscription is
compounded annually. All the balance that accumulates over time is

42 | P a g e
exempt from wealth tax. Moreover, it has low risk – risk attached is
Government risk. PPF is available at post offices and banks.

8.4 Illustration
If the account is opened in FY 1999-2000 and today is December
2009 that means the current FY is 09-10, previous FY is 08-09 and
4th FY is 05-06 so the amount which we can partially withdrawal
would be 50% of account balance dated on 31st March 2006 or 31st
March 2009 which ever would be lesser and in the below mention
case it would be Rs 125000 which is 50% of the account balance as
on 31st March 2006.

Date PPF A/C Balance

31st March 2000 10000
31st March 2001 25000
31st March 2002 75000
31st March 2003 100000
31st March 2004 125000
31st March 2005 200000
31st March 2006 250000
31st March 2007 275000
31st March 2008 350000
31st March 2009 400000

43 | P a g e
Type of Account Minimum limit Maximum limit
Public Provident INR 500 in a INR 1,50000 in a
Fund (Individual financial year. financial year.
account on his
behalf or on behalf
of minor of whom
he is the guardian)

8.5 Eligibility
Individuals who are residents of India are eligible to open their
account under the Public Provident Fund scheme. A PPF account may
be opened under the name of a minor by his/her legal guardian.
However, each person is eligible for only one account under his/her
name.
Non-resident Indians (NRIs) are not eligible to open an account under
the Public Provident Fund Scheme. However a resident who becomes
an NRI during the 5 years' tenure prescribed under Public Provident
Fund Scheme, may continue to subscribe to the fund until its maturity
on a non-repatriation basis.

8.6 Investment and Returns

A minimum yearly deposit of Rs. 500 is required to open and
maintain a PPF account, and a maximum deposit of Rs.1.5 lakhs
(w.e.f April 2014) can be made in a PPF account in any given
financial year. The government of India decides the rate of interest for
PPF account. The current interest rate effective from 1 April 2013 is
8.7% Per Annum(compounded annually). Interest is calculated on the
lowest balance between the close of the fifth day and the last day of
every month.

44 | P a g e
8.7 Loans
Loan facility is available from 3rd financial year up to the 5th
financial year. The rate of interest charged on loan taken by the
subscriber of a PPF account on or after 01.12.2011 shall be 2% more
than the prevailing interest on PPF. However, the rate of interest of
1% more than PPF interest p.a. shall continue to be charged on the
loans already taken or taken up to 30.11.2011.

8.8 Withdrawals from PPF Account

There is a lock-in period of 15 years and the money can be withdrawn
in whole after its maturity period. However, pre-mature withdrawals
can be made from the end of the sixth financial year from when the
PPF commenced. The maximum amount that can be withdrawn pre-
maturely is equal to 50% of the amount that stood in the account at
the end of 4th year preceding the year in which the amount is
withdrawn or the end of the preceding year whichever is lower.
After 15 years of maturity, full PPF amount can be withdrawn and all
is tax free, including the interest amount as well.

8.9 PPF Defaults and Revivals

If any contribution of minimum amount in any year is not invested
then the account will be deactivated. To activate you need to pay
Rs.50 as penalty for each inactive year also you need to pay Rs.500
for each inactive year’s contribution. In case death of account holder
then the balance amount will be paid to his nominee or legal heir even

45 | P a g e
before 5 years too. So nominees or legal heirs are not eligible to
continue the deceased account.
If balance amount is more than Rs.1, 00,000 then deceased nominee
or legal heir has to prove the identity to claim the amount.

8.10 PPF Tax Concessions

Interest earned is fully exempted from tax without any limit. Annual
contributions qualify for tax rebate under Section 80C of income tax.
Contributions to PPF accounts of the spouse and children are also
eligible for tax deduction. Balance in PPF account is not subject to
attachment under any order or decree of court. But, Income Tax
authorities can attach the account for recovering tax dues. The highest
amount that can be deposited is 1,50,000 (please note that the limit
has been increased from 1,00,000 to 1,50,000 in 2014-15 budget, but
the circular has not yet been issued, so this is sort of pending). Tax
bracket for PPF is EEE (i.e. Exempt, Exempt, Exempt). So
contribution is exempted under 80C, Interest earned is tax exempted
and withdrawal is also tax exempted
One can withdraw the investment made in 1st year only in 7th year.
However, loan against investment is available from 3rd financial year.

8.11 Benefits of PPF

1. Benefits under Section 80C reduces your tax liability for the
amount you invest. For example, if one invests Rs. 50,000 in a year,
its taxable income gets reduced by Rs. 50,000.
2. An account can be opened for even the youngest member of family.

46 | P a g e
3. One can make multiple deposits, up to 12 in a year.
4. Around 50% of the deposit can be withdrawn after 7 years without
any penalty. 5. The entire amount one gets on maturity is tax-free.

8.12 Downsides of PPF

1. There is a lock-in period of 15 years- one can only make partial
withdrawals during this period.
2. Interest rate can change every year depending on the government’s
decision. It could therefore go lower than the year in which you
opened the account. This could affect ones earning from PPF.
3. One can operate one account per person. If one shifts residence,
one can request its bank to move its account to a branch closer to its
new residence.
4. Premature closure may be allowed only in case of a genuine
emergency and that too only at the end of 5 years from the end of the
year in which the account was opened.

8.13 Procedure for Investing inPPF

1. One can open a PPF account in any post office or public sector
bank or even some private banks as specified by the government from
time to time.
2. One can open only one PPF account where you can deposit a
maximum of Rs. 1, 50,000 per year. One needs to deposit a minimum
of Rs. 500 every year to keep their account active. 3. There is no age
47 | P a g e
limit for opening an account. One can even open an account in the
name of a minor.
4. One can invest any amount ranging from Rs. 500 to Rs. 1, 50,000
in a year in multiples of Rs. 5. For example, one can invest Rs. 555 or
Rs.550, but not Rs.552.

8.14 Conclusion
Public Provident Fund (PPF) is a long term investment option. It
helps the investor to build wealth and to meet his long term
objectives, like his retirement, children’s marriage or education.
Public Provident Fund (PPF) is also beneficial for its tax benefits.
Investment is tax-deductible under 80C, and interest is tax free.
Overall, Public Provident Fund (PPF) is a very good investment
option for Indians.

48 | P a g e
 Chapter 9
Advantages and Disadvantages of fixed
income securities

Advantages:
Fixed income securities are commonly used to diversify an investor's
portfolio, as they reduce the overall risk of an asset allocation or
investment strategy weighted heavily in the stock market. Fixed
income securities such as corporate bonds, government bonds,
preferred company stocks and certificates of deposit (CDs) are more
stable than pure equity holdings. Investors tend to rely on this asset
class more during times of economic downturn or when steady
income is the objective of the investment account. Although fixed
income securities do not provide a great potential for upside return
through capital appreciation or the opportunity to outpace inflation,
income investing through fixed securities offers some unique
advantages over growth investing through equity.

Stability of Principal
One advantage of investing in fixed income securities is the peace of
mind that comes from a stable portfolio balance and capital
preservation. By definition, fixed income securities are required to
repay the original amount of the investment, known as the principal
balance, in full at a specific date in the future or in increments spread
out over the duration of the investment. When fixed income securities
are highly rated, as is the case with U.S. government bonds, there is
minimal risk that the entity offering the fixed income security will be

49 | P a g e
unable to repay investors in full when the investment matures.
Similarly, financial institutions that offer CDs are backed by deposit
insurance agencies that safeguard customer deposits should a bank or
credit union go bankrupt. This reduces or eliminates the concern
investors have about portfolio fluctuations over time and the potential
of not meeting the objective of the investment account due to market
volatility.

Steady Income Stream

In addition to the benefit of capital appreciation, fixed income
securities provide investors with a steady stream of income generated
from a portfolio's balance. Bonds, preferred stocks and CDs all pay
steady dividend and interest payments to investors, creating a
consistent cash inflow to investors. Fixed interest and dividend rates
are set when the security is issued, and these payments are guaranteed
as long as the issuing entity does not default. Federal government
bonds are the least likely to default on interest and dividend
payments, while corporate bonds with lower credit agency ratings
bear more default risk for investors. This feature of fixed income
securities is particularly attractive to investors near or in retirement
who are receiving little or no income from other sources.

Higher Claim to Assets

Fixed income investors also benefit from their position in the capital
structure of an entity issuing both equity and debt investments.
Investors in bonds of a corporation have a higher priority over
common and preferred stockholders of the same corporation should
the company declare bankruptcy or be liquidated. Bondholders, then,
are more likely to be repaid their principal investment when assets are
distributed during a liquidation event.
50 | P a g e
Disadvantages:
Fixed-income securities attract investors because they provide
guaranteed returns in the form of fixed, regular cash payments.
However, investing in fixed-income securities also carries some
disadvantages. Their generally low risk compared to investments that
don't come with guarantees often translates to lower returns.
Additionally, many fixed-income securities, such as Treasury bonds
(T-bonds), impose penalties on investors who withdraw their
premiums before a set period of time has passed.
A fixed-income security is an investment that provides fixed
payments at regular intervals for the duration that the investor holds
the security. Common forms of fixed-income securities include T-
bonds and corporate bonds. Consider an investor who purchases a 20-
year T-bond at a par value of $1,000 and an annual yield of 5%. This
bond pays the investor $50 per year until the 20 years are over, when
his premium of $1,000 is returned.
Preferred stock also falls under the category of fixed-income security.
It pays investors a dividend on a fixed schedule. The amount of a
dividend is either a fixed dollar amount or a fixed percentage of share
value. The dividend payments that a preferred stockholder receives
are analogous to the annual payments received by a bondholder.
When the investor sells his preferred stock, his premium is returned,
plus or minus any gains or losses accrued over time.
Regardless of what the economy or the markets are doing, fixed-
income securities pay a return. The bond investor described above
receives his $50 per year even during a sharp recession or a
depression. The guaranteed dividends received by a preferred stock
holder enhance gains and mitigate losses. For example, if the stock
falls by 5% but pays a 3% dividend, the investor's loss, effectively, is
only 2%.

51 | P a g e
These built-in advantages come with corresponding disadvantages. In
nearly all matters of finance, risk and reward correlate positively. For
this reason, high-risk sectors such as tech startups offer investors the
potential for the biggest gains. Government securities, while safe,
rarely make investors rich in short order. The guaranteed cash
payments that fixed-income securities provide lower their risk. With
lower risk comes lower rewards. Fixed-income securities typically do
not gain as aggressively as securities that do not provide guaranteed
fixed payments.
Furthermore, many fixed-income securities tie up an investor's
principal balance for a long period of time. If he wants to retrieve it,
he's assessed a penalty that often wipes out any money he has made in
the interim. For example, T-bonds have maturities of 10 years or
greater. An investor isn't returned his premium for a decade or longer.
In contrast, traditional stock investing, when done shrewdly, can
produce big gains in far less than a decade, and the investor can
actually access his money.

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 Chapter 10
Types of Risk
Fixed income is generally considered to be a more conservative
investment than stocks, but bonds and other fixed income investments
still carry a variety of risks that investors need to be aware of.
Diversification can be a good way to minimize many of the risks
inherent in fixed income investing. In the world of fixed income,
diversification takes on many forms, including diversification across
bond type, bond issuer (such as the federal or a state government, or a
corporation); duration (short-, intermediate-, and long-term bonds);
credit quality and yield (high-quality bonds are relatively safer but
pay lower rates, while less credit-worthy issuers will pay higher rates
for greater risk); and tax treatment (most municipal bonds, for
instance, offer investors tax-free income). Bond funds can also
provide professional diversification at a lower initial investment. But
the securities held in bond funds are all still subject to several risks,
which can affect the health of a fund.
Interest rate risk
Investors don’t have to buy bonds directly from the issuer and hold
them until maturity. Instead, bonds can be bought from and sold to
other investors on what’s called the secondary market. Bond prices on
the secondary market can be higher or lower than the face value of the
bond depending on the economic environment and market
conditions—both of which can be affected significantly by a change
in interest rates. If interest rates rise, bond prices usually decline.
That’s because new bonds are likely to be issued with higher yields as
interest rates increase, making the old or outstanding bonds less
attractive.

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If interest rates decline, however, bond prices usually increase, which
means an investor can sometimes sell a bond for more than face
value, since other investors are willing to pay a premium for a bond
with a higher interest payment, also known as a coupon.
If you decide to sell a bond before its maturity, the price you receive
could result in a loss or gain depending on the current interest rate
environment. The longer a bond’s maturity—or the longer the average
duration for a bond fund—the greater the impact a change in interest
rates can have on its price. In addition, zero‐coupon bonds, or those
bonds with lower coupon (or interest) rates are more sensitive to
changes in interest rates and the prices of these types of bonds (or
bond funds or ETFs that hold these bonds) tend to fluctuate more than
higher‐coupon bonds in response to rising and falling rates. However,
if you’re holding a bond until maturity, interest rate risk is not a
concern.
Credit risk
Bonds carry the risk of default, which means that the issuer may be
unable or unwilling to make further income and/or principal
payments. In addition, bonds carry the risk of being downgraded by
the rating agencies which could have implications on price. Most
individual bonds are rated by a credit agency such as Moody’s or
Standard & Poor’s (S&P) to help describe the creditworthiness of the
issuer or individual bond issue. U.S. Treasury bonds have backing
from the U.S. government and, as such, are considered to have an
extremely low risk of default —though Treasury bonds can be (and
have been by S&P) downgraded from their top‐notch status in times
of economic or political difficulty. Since all bonds are evaluated
relative to Treasury bonds, this can affect the credit quality of other
generally highly rated bonds, such as agency bonds.
Bonds are typically classified as investment grade quality (from
medium to the highest credit quality) or non-investment grade
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(commonly referred to as high yield bonds). Bond funds and bond
ETFs are not themselves rated by the agencies, but the investments
they hold may be. You can find out the quality of a fund’s
investments by reading the fund’s prospectus.
Credit risk is a greater concern for high‐yield or non-investment grade
bonds and bond funds that invest primarily in lower‐quality bonds.
Some bond funds may invest in both investment grade quality and
high‐yield bonds. It's important to read a fund’s prospectus before
investing to make sure you understand the fund’s credit quality
guidelines.
Since bond funds and bond ETFs are made up of many individual
bonds, diversification can help mitigate the credit risk of an issuer
defaulting or being downgraded, which would affect bond prices. An
Investment Grade bond fund will typically have no less than 80%
allocation to investment grade bonds; whereas a High Yield bond
fund will typically have the majority of the portfolio’s assets invested
in non-investment grade bonds.
In the case of Certificates of Deposit (CDs), including the brokered
CDs that Fidelity offers, the presence of the FDIC insurance
guarantee protects investors from the credit risk of the issuer
providing their total investment in that issuer remains under $250K,
per holder, per account type. Any investment amount beyond the
$250K FDIC insurance protection are subject to credit risk and
potential loss for the investor if the issuing bank or financial
institution declares bankruptcy.
Inflation risk
Inflation risk is a particular concern for investors who are planning to
live off their bond income, though it’s a factor everyone should
consider. The risk is that inflation will rise, thereby lowering the
purchasing power of your income. To combat this risk, you may want

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to consider U.S. Treasury Inflation-Protected bonds (TIPS). The TIPS
principal is adjusted for any rise in the Consumer Price Index, so
when the bond matures and the principal is returned, that amount will
be higher to correspond with the amount of inflation. (TIPS do not
adjust at all if inflation decreases over the life of the bond.) Because
this inflation factor is a component of the interest payment
calculation, interest payments for TIPS are variable, even though the
coupon is fixed. There are bond funds that invest exclusively in TIPS,
as well as some that use TIPS to offset inflation risk that may affect
other securities in the portfolio.
Call risk
A callable bond has a provision that allows the issuer to call, or repay,
the bond early. If interest rates drop low enough, the bond's issuer can
save money by repaying its callable bonds and issuing new bonds at
lower interest rates. If this happens, the bondholder's interest
payments cease and they receive their principal early. If the bond
holder then reinvests the principal in a bond of similar characteristics
(such as credit rating), he or she will likely have to accept a lower
interest payment (or coupon rate), one that is more consistent with
prevailing interest rates. Therefore, the investor’s total return will be
lower and the related interest payment stream will be lower—a more
serious risk to investors dependent on that income.
Before purchasing a callable bond investors should evaluate not only
the bond's Yield to Maturity (YTM) but also take account of the Yield
to Call or the Yield to Worst (YTW). Yield to Worst calculates the
worst yield from the two potential outcomes - either that the bond
runs through its stated maturity date, or is redeemed earlier.
Prepayment risk
Some classes of individual bonds, including mortgage-backed bonds,
are subject to prepayment risk. Similar to call risk, prepayment risk is

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the risk that the issuer of a security will repay principal prior to the
bond’s maturity date, thereby changing the expected payment
schedule of the bonds. This is especially prevalent in the mortgage-
backed bond market, where a drop in mortgage rates can initiate a
refinancing wave. When homeowners refinance their mortgages, the
investor in the underlying pool of mortgage-backed bonds receives his
or her principal back sooner than expected, and must reinvest at
lower, prevailing rates.
Liquidity risk
Liquidity risk is the risk that you might not be able to buy or sell
investments quickly for a price that is close to the true underlying
value of the asset. When a bond is said to be liquid, there’s generally
an active market of investors buying and selling that type of bond.
Treasury bonds and larger issues by well known corporations are
generally very liquid. But not all bonds are liquid; some trade very
infrequently(e.g. Municipal Bonds), which can present a problem if
you try to sell before maturity—the fewer people there are interested
in buying the bond you want to sell, the more likely it is you’ll have
to sell for a lower price, possibly incurring a loss on your investment.
Liquidity risk can be greater for bonds that have lower credit ratings
(or were recently downgraded), or bonds that were part of a small
issue or sold by an infrequent issuer.
Weighing the risks of individual bonds vs. bond funds and bond ETFs
Diversification
Because bond funds and bond ETFs are generally diversified across
multiple securities a single purchase made with a limited investment
amount can provide access to potentially hundreds of different
issuers. This can help lessen the downside impact from a credit event
impacting any one of the issuers.

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Liquidity
The liquidity risk just described above can be more exaggerated with
an individual bond. In certain cases there may not be an active two-
way market for a specific bond and the price discovery process could
take several hours. With a bond fund on the other hand the investor
has access to buy or sell at the end of the day, and with a bond ETF,
throughout the market trading day.
Return of Principal
With individual bonds so long as the issuer does not default an
investor will be paid the bond’s par value when the bond matures. A
bond fund or bond ETF on the other hand does not mature and its
value will fluctuate. While a bond’s price can fall the investor has an
option to wait until it matures or is redeemed.
Income Predictability
The future cash flows of an individual bond from coupons and
principal payments are contractually transparent and can be predicted
– with the caveat of insolvency as described above. With a bond fund
or bond ETF, because the underlying holdings are bought and sold the
income that they generate in the aggregate will fluctuate over time
and is unknowable in advance. Defined-maturity bond funds and
ETFs attempt to bridge the gap between bond funds and individual
bonds and offer more predictability of income than traditional bond
funds. Such funds “mature” on a specified date, at which time the
proceeds are distributed to shareholders.

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 Conclusion
The benefits of holding fixed income securities as part of a balanced
portfolio are timeless. When held in a diversified form across many
tenors and investment grade issuers, fixed income asset class returns
provide a narrower, less volatile range of investment outcomes than
equities. Fixed income securities as an asset class, principally
provides coupon income liquidity and high levels of capital stability.
By including a fixed income allocation in a balanced portfolio, these
features also provide portfolio efficiency gains from reducing the
variability of returns below the levels of the weighted average of the
combined asset classes. An allocation to the Fixed-Income sector
should be part of a diversified portfolio regardless of the interest rate
environment. A rising rate environment provides a strong headwind to
portfolios, but there are certain strategies an investor can implement to
minimize a portfolio’s sensitivity. Lowering duration, increasing
credit exposure and maximizing reinvestment of income are three
common techniques accessible to investors. The choice of investment
vehicle also plays an important role in how a fixed-income portfolio
performs in a rising rate environment. A strategy for rising interest
rates should be implemented within your long-term investment plan.
Together with an Financial Advisor, one can determine which
strategy best fits ones risk tolerance, time horizon liquidity needs, and
long-term goals.

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 Bibliography
 https://www.fidelity.com/learning-center/investment-
products/fixed-income-bonds/fixed-income-investing-risks
 http://googleweblight.com/i?u=http://www.investopedia.com/as
k/answers/041315/what-are-main-disadvantages-fixed-income-
securities.asp&grqid=x4Px8JVy&hl=en-IN&r=1
 http://www.investopedia.com/ask/answers/032515/what-are-
main-advantages-fixed-income-securities.asp
 Books
 1. Pottayil Vinod,“What Every Indian Should Know Before
Investing”, Imagine Books, Mumbai, 2012.

 2. Tuckman Bruce, “Fixed Income Securities”, John Wiley & Sons,

United
 States, 2002.

 3. Chaturvedi Meenakshi & Khare Shruti. 2012. Study of Saving

Pattern and Investment Preferences of Individual Household
in India. International Journal of Research in Commerce &
Management. Volume no. 3 (2012), Issue no. 5 (May)

 4. Kanti Das Sajay 2012, Middle Class Household’s Investment

Behavior: An Empirical Analysis. Radix International Journal of
Banking, Finance and Accounting. Volume 1, Issue 9(September
2012)

 5. N. Geetha & Ramesh M. 2012. A Study on Relevance of

Demographic Factors in Investment Decisions. International

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Journal of Financial Management IJFM – Vol.1, Issue 1 Aug 2012
39-56

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