Advance Financial Planning Study Notes Part 1

Advance Financial Planning- Study Notes Part - 1
Roots Institute of Financial Markets

RIFM
Study Notes-Part 1
Advanced Financial Planning
i Roots Institute of Financial Markets

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Welcome To RIFM
Thanks for Choosing RIFM As Your Guide To Help You In CFP/NCFM Certification.
Roots Institute Of Financial Markets Is An Advanced Research Institute Promoted By

Mrs. Deep Shikha CFPCM. RIFM Specializes In Financial Market Education And
Services. RIFM Is Introducing Preparatory Classes And Study Material For Stock
Market Courses Of NSE , NISM And CFP Certification. RIFM Train Personals
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Faculty And Content Team, RIFM
ii Roots Institute of Financial Markets

Our Team
Deep Shikha Malhotra CFPCM
 M.Com., B.Ed.
 AMFI Certified For Mutual Funds
 IRDA Certified For Life Insurance
 IRDA Certified For General Insurance
 PG Diploma In Human Resource Management
CA. Ravi Malhotra

 B.Com.
 FCA
 DISA (ICA)
CM
 CERTIFIED FINANCIAL PLANNER
Vipin Sehgal CFPCM

 B.Com.
 NCFM Diploma In Capital Market (Dealers) Module
Neeraj Nagpal CFPCM

 B.Com.
NCFM Diploma In :
 Capital Market (Dealers) Module
 Derivatives Market (Dealers) Module
 Commodities Market Module
Kavita Malhotra
 B.Com.
Certification In Following Modules Of CFPCM Curriculum (FPSB India)
 Risk Analysis & Insurance Planning
 Retirement Planning & Employees Benefits
 Investment Planning
 Tax Planning & Estate Planning
 Advanced Financial Planning
3 Roots Institute of Financial Markets

Exam Pattern
Pattern of Questions in a Case Study
Module I Module II Module III Module IV Module V
No_Item Mark No_Item Mark No_Item Mark No_Item Mark No_Item Mark
s s s s s s s s s s
2 2 4 1 2 0 0 1 2 1 2
3 1 3 1 3 1 3 0 0 1 3
Marks
Categor
y
4 0 0 1 4 0 0 1 4 0 0
5 0 0 0 0 1 5 2 10 1 5
Total 3 7 3 9 2 8 4 16 3 10
A student who scores 50% or more will pass the examination and anyone who scores below 50%
(exclusive) will fail the examination.
There is no negative marking in the Examination.
Successful students in the CFP Certification examination are not given their scores or ranks as
CM
practiced in most international professional certification examinations. However, given the

aspiration needs of the students, grades will be provided to the successful students. Unsuccessful
students shall get their marks in percentage terms along with the result.
The following grading system will be used to provide grades.
Grade Score (Percentage)
A Equal and above 75%
B Equal and above 60% and less than 75%
C Equal and above 50% and less than 60%
Fail Less than 50%

Syllabus
COURSE DESCRIPTION: This module builds upon the foundations in Financial Planning and the
knowledge requirements in Modules 2 to 5 to enable the CFP professional to construct a comprehensive
Financial Plan for a client. Miscellaneous topics are also covered in this module.
LEARNING OBJECTIVES: At the end of this module, a student should be able to:
1. Determining the client’s financial status by analyzing and evaluating the client's information.
2. Developing and preparing a client-specific Financial Plan tailored to meet the goals and
objectives of client, commensurate with client’s value, temperament, and risk tolerance.
3. Implement and monitor the Financial Plan.
DETAILED CLASS OUTLINE:
Financial Planning Process
1. Establishing client- planner relationships
a. Explain issues and concepts related to overall Financial Planning process, as appropriate to the
client
b. Explain services provided, the process of planning, documentation required
c. Clarify client’s and certificant’s responsibilities
2. Gathering client data and determining goals and expectations
a. Obtain information from client through interview/ questionnaire about financial resources and
obligations
b. Determine client’s personal and financial goals, needs and priorities
c. Assess client’s values, attitudes and expectations
d. Determine client’s time horizons
e. Determine client’s risk tolerance level
f. Collect applicable client records and documents
3. Determining the client’s financial status by analyzing and evaluating the client's information
A. General
a. Current financial status (e.g., assets, liabilities, cash flow, debt management)
b. Capital needs
c. Attitudes and expectations
d. Risk tolerance
e. Risk management

f. Risk exposure
B. General Needs
a. Emergency funds
b. Children’s education
c. Children’s marriage
d. Buying real assets like home, car, durables, etc.
e. Future lifestyle needs
C. Special needs
a. Divorce / remarriage considerations

b. Charitable planning
c. Adult dependent needs
d. Disabled child needs
e. Education needs
f. Terminal illness planning
g. Entrepreneurial needs planning
D. Risk management
a. Life insurance needs and current coverage

b. Disability insurance needs and current coverage
c. Medical insurance needs and current coverage
d. Long – term care insurance needs and current coverage
e. Homeowners insurance needs and current coverage
f. Auto insurance needs and current coverage
g. Commercial insurance needs and current coverage
h. Other liability insurance needs and current coverage (e.g., umbrella, professional, errors and
omissions, directors and officers)
E. Retirement
a. Current retirement plan tax exposures

b. Current retirement plans
c. Retirement strategies
F. Employee benefits
a. Available employee benefits

b. Current participation in employee benefits
G. Investments

a. Current investments
b. Current investment strategies and policies
H. Taxation
a. Tax returns
b. Current Tax strategies
c. Tax compliance status (e.g., estimated tax )
d. Current tax liabilities
I. Estate planning
a. Estate planning documents

b. Estate planning strategies
4. Analyze Client Objectives, Needs and Financial Situation
a. Analysis of relevant information

b. Need for specialist advice
c. Issues that require further clarification
5. Developing and presenting the Financial Plan
A. Developing and preparing a client-specific Financial Plan tailored to meet the goals and objectives of
client, commensurate with client’s value, temperament, and risk tolerance, covering:
1. Financial position
a. Current statement
b. Projected statement
c. Projected statement with recommendations
2. Cash flow
a. Projections
b. Recommendations
c. Projections with recommendations
3. Capital needs at retirement
a. Projections
b. Recommendations

c. Projections with recommendations
4. Capital needs projections at death
a. Recommendations
b. Projections with recommendations
5. Capital needs: disability
a. Recommendations
6. Capital needs: General needs
a. Recommendations
7. Capital needs: special needs
a. Recommendations
8. Income tax
a. Projections
b. Recommendations
c. Projections with strategy recommendations
9. Employee benefits
a. Projections
10. Asset allocation
a. Statement
b. Strategy recommendations
c. Statement with recommendations
11. Investment
a. Recommendations
b. Policy statement

c. Policy statement with recommendations
12. Risk
a. Assessment
b. Recommendations
13. List of prioritized action items
a. Presenting and reviewing the plan with the client

b. Collaborating with the client to ensure that plan meets the goals and objectives of the client,
and revising as appropriate
6. Implementing the Financial Plan
a. Assist the client in implementing and recommendations

b. Coordinate as necessary with other professionals, such as accountants, attorneys, real estate
agents, investment advisors, stock brokers and insurance agents
7. Monitoring the Financial Plan
a. Monitor and evaluate soundness of recommendations

b. Review the progress of the plan with the client
c. Discuss and evaluate changes in client’s personal circumstances, (e.g., birth/ death, age, illness,
divorce, retirement)
d. Review and evaluate changing tax law and economic circumstances
e. Make recommendations to accommodate new or changing circumstances
Miscellaneous Topics
8. Internet Resources
a. Internet usage and application

b. Transactions over the net
c. Issues of security
d. Financial Planning using the Internet
9. Foreign exchange issues for individuals
a. Foreign Exchange Management Act (FEMA)

b. Currency risk management
10. Financial Planning for special needs and clients

a. Individual life cycle

b. Financial Planning for unmarried clients, single parents, widows/widowers, etc.
c. Financial Planning for returning Non Resident Indians
d. Other special needs and options (e.g., divorce, bankruptcy)

Index
Part 1
Conents Page No.
Unit 1
Introduction to financial Planning 3-7
A. Financial planning process 8-14
B. Time value of money 15-17
C. Cash flow management 18-35
D. Code of Ethics 36-40
E. Financial Ratios 41-43
F. Financial Calculator Operations 44-61
G. Excel Applications
Unit 2
Risk Analysis and Insurance Planning
A. Risk analysis 65-74
B. Review of life insurance 75-109
C. Life insurance need analysis 110-122
D. Review of non life insurance 123-144
E. Settlement of claims in insurance 145-153
Unit 3
Investment Planning
A. Risk return analysis 157-173
B. Asset allocation 174-183
C. Derivatives 184-205
D. Mutual fund 206-211
E. Equity valuation 212-220
F. Small saving schemes 221-228
G. Bond return & valuation 229-235

UNIT
1
INTRODUCTION TO FINANCIAL PLANNING
A. Financial planning process

B. Time value of money
C. Cash flow management
D. Code of Ethics
E. Financial Ratios
F. Financial Calculator Operations
G. Excel Applications

A. TIME VALUE OF MONEY
Calculate and interpret time value of money
Money has time value. A rupee today is more valuable than a rupee a year hence. Why?
There are several reasons:
 Individuals, in general, prefer current consumption to future consumption.

 Capital can be employed productively to generate positive returns. An investment of
one rupee today would grow to (1+r) a year hence (r is the rate of return earned on
the investment.)
 In an inflationary period a rupee today represents a greater real purchasing power
than a rupee a year hence.
Most Financial problems involve cash flows occurring at different points of time. These cash
flows have to be brought to the same point of time for purposes of comparison and
aggregation. Hence you should understand the tolls of compounding and discounting which
underlie most of what we do in finance-from valuating securities to analyzing projects, from
determining lease rentals to choosing the right financing instruments, from setting up the
loan amortization schedules to valuing companies, so on and so forth.
Calculation of future value
Future value measures the nominal future of money that a given sum of money is „worth‟ at a
specified time is the future assuming a certain interest rate.
Formula used
FV= PV (1+R) 1(1+R)2 … (1+R)N ON FC-200V

Press CMPD
FV= PV (1+R)N N= Enter Value
I = Enter Value
Where, PV= Enter Value
FV = Solve
FV= Future Value
PV= Present Value
R= rate of interest/Return
N= Term Period
Example 1 Calculate the maturity amount of Rs. 18,000 if invested at 8% per annum for 5
years.
a. Rs. 26448 b. Rs. 26500 c. Rs. 25100 d. Rs. 16541
Solution Press CMPD

Set: End, N= 4, I% = 8, PV= -18000, FV=Solve= 26448
Calculation of Present value
Present value is the value on a given date of future payment or series of future payments,
discounted to reflect the time value of money and other factors such as investment risk.

Formula used
FV= PV (1+R) 1(1+R)2 … (1+R)N ON FC-200V

FV= PV (1+R)N Press CMPD
PV= FV/(1+R)n N= Enter Value
I = Enter Value
Where, PV= Solve
FV= Future Value FV= Enter Value
PV= Present Value
R= rate of interest/Return
N= Term Period
PV= Future Amount/ (1+ Interest
Rate) term
Example 2 How much must be invested today, at 9% p.a. to accumulate enough to retire a
Rs. 100000 debt due seven years from today?
a. Rs. 32650 b. Rs. 54704 c. Rs. 61230 d. Rs. 87950
Solution
Press CMPD, Set: End, N= 7, I-9, PV= Solve= -54703.42, FV=100000
Calculation of Interest & term
Interest
Interest is a fee, paid on borrowed capital. Assets lend include money, shares, consumer
goods through hire purchase, major assets such as aircraft, and even entire factories in
finance lease arrangements. The interest is calculated upon the value of the assets in the
same manner as upon money. Interest can be thought of as „rent on money‟. For example, if
you want to borrow money from the bank, there is a certain rate you have to pay according
to how much you want loaned to you.
The fee (interest) is compensation to the lender for foregoing other useful investments that
could have been made with the loaned money. Instead of the lender using the assets
directly, they are advanced to the borrower. The borrower then enjoys the benefits of using
the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of
the fee paid by the borrower for the privilege. The amount lent, or the value of the assets
lent, is called the principal. This principal value is held by the borrower on credit. Interest is
therefore the price of credit, not the price of money as it is commonly and mistakenly-
believed to be. The percentage of the principal that is pad as a fee (the interest), over a
certain period of time, is called the interest rate.
On FC-200V, Press CMPD, N= Enter Value, I= Solve, PV= Enter Value, FV= Enter Value
Term
Term is defined as a limited period of time, a point in time at which something ends, or a
deadline, as for making a payment.

Thumb Rule
This rule is just like a quick calculation. It might not give you the exact answers but will give
you the closest answer.
Rule of 72: To estimate the number of periods required to double an original investment,
divide the most convenient “rule-quantity” by the expected growth rate, expressed as a
percentage.
Steps Involved:
1. Find out your interest rate

2. Second…….do the math
72/interest rate= Years
Rule of 69: A rule stating that an amount of money invested at r percent per period will
double in 69/r (in percent) + 3.5 periods.
69/interest rate+0.35= years
For example, if interest rate is 9%, the investment will double in a little over 8 years
69/9+0.35= 8.016 years.
Rule of Tripling Investments
Rule of 115: To estimate how long it takes to triple your money, divide 115 by your expected
interest rate (or rate of return)
115/interest rate= years
For instance, an investment will triple in approximately 11.5 years, if rate of interest is 10%
Example 3 An analyst estimates that Mars Software‟s earning will grow from Rs.3 per share
to Rs. 4.50 per share over the next eight years. The rate of growth in Mars Software‟s
earning is closest to:
a. 4.9% b. 5.2% c. 6.7% d. 7.0%
Set: End, N= 8, I=Solve= 5.2, PV= -3, FV= 4.5
Example 4 If Rs. 5000 is invested in a fund offering a rate of return of 12 percent per year,
approximately how many years will it take for the investment to reach Rs. 100000?
a. 4 years b. 5 years c. 6 years d. 7 years
Solution 72/12= 6 years
Calculation of annuities
Annuity: The term annuity is used in reference to any terminating stream of fixed annuity
payments over a specified period of time. Some examples of annuity are:
Rent Loan EMI‟s Pension, etc.
Following are the various types of annuities-

 Ordinary Annuity/ Annuity in Arrears: An ordinary annuity is essentially a level

stream of cash flows made at the end of each period for a fixed period of time.
Straight bond coupon payments are normally referred to as ordinary annuities.
 Annuity Due: An annuity whose payment is to be made immediately rather than at

the end of the period.
 Annuity certain: Annuity certain is a plan which makes payments for a specified
period of time regardless of whether the annuitant is alive or dead during that period.
 Deferred Annuity: A type of annuity contract that delays payment of income,

installments or a lump sum until the investor elects to receive them. This type of
annuity has two main phases, the savings phase in which you invest money into the
account, and the income phase in which the plan is covered in to an annuity and
payments are received.
 Perpetuity Annuity Forever: Perpetuity forever is an annuity whose payments

continue forever.
 Growing Annuity: A growing annuity is a finite number of cash flows growing at a

constant rate. The formula for the present value of a growing annuity is:
PV= CF0 (1+g)/(k-g)*[1-(1+g)/(1+k)N ]

Where, CF= Cash flows, G= Growth Rate, K= Interest Rate, N= Number of years
FV= PMT [{(1+r)n - (1+g)n }]/(1+r)-(1+g)
 Payment (PMT) The payment is an equal cash flow that occurs each sub period in
an annuity
Faculty Comment: Always assume an annuity is an ordinary annuity unless the facts clearly
indicates otherwise.
Important Note: Always use begin Mode on your calculator if it is Annuity due.
Example 1 Find the present value of an annuity of Rs. 1000 payable at the end of each year
for 8 years, if rate of interest is 5% p.a.
a. Rs. 6463 b. Rs. 3231 c. Rs. 4265 d. Rs. 1614
Set: End, N= 8, I= 5, PV= Solve= 6463.21, PMT= -1000
Example 2 Alfa add Rs. 7000 per year to an account for 10 years. If rate of interest is 6%
per year on the money. What is the worth of the account at the end of the 10 years?
Rs. 64622 b. Rs. 92266 c. Rs. 72550 d. Rs. 80124
Set: End, N=10, I= 6, PMT= -7000, FV=Solve=92266
Loan repayment schedule
The present value annuity formula can be applied in a variety of contexts. Its important
applications are discussed below.

How much can you borrow for a Car After reviewing your budget, you have determined that
you can afford to pay Rs. 12,000 per month for 3 years toward a new car. You call a finance
company and learn that the going rate of interest on car finance is 1.5 percent per month for
36 months. How much can you borrow?
To determine how much you can borrow, we have to calculate the present value of Rs.
12000 per month for 36 months at 1.5 percent per month. Since the loan payments are an
ordinary annuity, the present value interest factor of annuity is:
PVIFAr, = 1-1/(1+r)n /r = (1-1/(1.015)36 /.015= 27.1
Hence the present value of 36 payments of Rs. 12,000 each is:
Present value= Rs. 12000*27.7= Rs. 332400
You can, therefore borrow Rs. 332400 to buy the car.
Period of Loan Amortization You want to borrow Rs. 1,080,000 to buy a flat. You approach
a housing finance company which charges 12.5 percent interest. You can pay Rs. 180000
per year toward loan amortization. What should be the maturity period of the loan?
The present value of annuity of Rs. 180000is set equal to Rs. 1000,000
180000*PVIFAn,r = 1,080,000
180,000*PVIFAn=? r=12.5%= 1,080,000
180,000[1-1/ (1.125) n /0.125] = 1080000
Given this equality the value of n is calculated as follows:
1-1/ (1.125)n /0.125= 1,080,000/180,000=6

1-1/ (1.125)n = 0.125*6= 0.75
1/ (1.125)n = 0.25
1.125n = 4
N log 1.125= log 4
N*0.0512= 0.6021
N= 0.6021/0.0512= 11.76 years
You can perhaps request for a maturity of 12 years.
Determining the loan Amortization Schedule Most loans are repaid in equal periodic
installments (monthly, quarterly, or annually), which cover interest as well as principal
repayment. Such loans are referred to as amortized loans.
For an amortized loan we would like to know (a) the periodic installment payments and (b)
the loan amortization schedule showing the break-up of the periodic installments payment
between the interest component and the principal repayment component. To illustrate how
these are calculated, let us look an example.
Suppose a firm borrow Rs. 1,000,000 at an interest rate of 15 percent and the loan is to be
repaid in 5 equal installments payable at the end of each of the next 5 years. The annual
installment payment A is obtained by solving the following equation.

Loan Amount= a *PVIFAn=5,r=15%
1,000,000 = A*3.3522
Hence A= 298,312
The amortization schedule is shown following table. The interest component is the largest for
year 1 and progressively declines as the outstanding loan amount decreases.
Loan Amortization Schedule
Year Beginning Annual Interest Principal Remaining

Amount (1) installment Repayment Balance 1-
(2) 2-3=4 4= 5
1 1,000,000 298,312 150,000 148,312 851,688
2 851,688 298,312 127,753 170,559 681,129
3 681,129 298,312 102,169 196,143 484,986
4 484,986 298,312 727,482 225,564 259,422
5 259,422 298,312 38,913 259, 399 23
 Interest is calculated by multiplying the beginning loan balance by the interest rate.
 Principal repayment is equal to annual installment minus interest
 Due to rounding off error a small balance is shown
Inflation- adjusted interest rates
Inflation Adjusted Rate of returns: Inflation adjusted rate of return is a measure that accounts
for the return periods inflation rate. Inflation adjusted returns reveals the return on an
investment after removing the effects of inflation.
It is calculated as follows:
Inflation Adjusted Return = (1+Return)/(1-Inflation Rate)-1
Example A bond that pays interest annually yields a 7.25 percent rate of return. The inflation
rate for the same period is 3.5 percent. What is the real rate of return on this bond?
a. 3.62% b. 3.75% c. 10.75% d. 8.50%
Solution: Real rate= 1+nominal rate/1+inflation rate-1*100= 1.0725/1.0350-1*100= 3.62%

Compound Interest calculation

Most of the banks and person dealing with funds use the word compounding interest
annually, semi-annually or quarterly etc. to understand better compound interest would
mean calculating the interest on interest also. The mathematical formula shall be as follow:
 C.I. = P [ ( 1+ r/100) -1] , where C.I. = compound interest

 If the interest rates for the successive fixed periods are r1%, r2%, r3% ..., then A
(Amount) is given by
A=P ( 1 +r1/100) (1+r2) (1+ r3)………………… where A= amount & principal ,

P= principal
For example
An amount of 5000/- is borrowed at the rate of 9% per annum for 3 years,
CI would be
C.I. =5000 x {(1+ .09)³-1} = 1475.145

A =5000 + 1475.145 = 6475.145
Operation
Press CMPD key
Input the following using scroll and exe keys
Set : begin / end select End using scroll and exe key
N : press 3 and enter exe key
I% : press 9 and enter exe key
PV : press 5000 and enter exe key
PMT : leave blank or press 0 and enter exe key*
FV : Press solve key, see the answer appears as -6475.145
Note : Using scroll key please enter the P/Y = 1 and C/Y = 1 as the same represents the
Installments per year and Compounding per year respectively. If the compounding is semi
annually then C/Y should be selected as 2 and for quarterly the same should be
selected as 4.
Note: Press ESC key to come back to previous screen
Note: To clear variables from the memory is to press SHIFT key and 9 key and EXE
key and chose the correct option to clear either setup, memory or all variables from
the memory

EMI calculation CMPD continues….
A very important tool for finance companies having the business of lending money and all
those also borrowing money and in the need to know that how much monthly installment
need to be paid for a particular loan.
Typically a person needs to know the present value of amount borrowed/lend and the
interest rate to be paid also the total number of installments to be used while returning the
amount borrowed. i.e.
PV = amount borrowed or lend i.e. INR 50000

I% = interest rate i.e. 12% p.a. i= I%/12/100 = 0.010
N = number of installments per year i.e. 15 years = 180 times
A typical way of calculating the EMI shall be taking the help of computer or a long sheet of
paper and lot of time in computing and yet not very sure about the way of doing. The formula
shall be as follows:
PV x i x (1+ i)ⁿ
= (1+ i)ⁿ-1
= 50000 x 0.01 x (1.01)

(1.01) 180 -1
= 600.08
EMI calculation without a calculator having the solving power like this is just impossible and
doing little simulations and variations in interest, principal etc, the working becomes very
tough, but the use of FC 200V is very simple, faster and economical, let‟s see
Press CMPD key and using the scroll and exe key enter the following data
Set = End key

N = Press 180 and enter Exe key (15 years x 12 months)
I% = Press 12 and enter Exe key
PV = 50000 exe key
PMT = Solve key
FV = Press 0 and enter Exe key
P/Y =12 as the installments per year is 12 the duration of loan is 15 years
C/Y =12 as the compounding also is monthly so in a year 12 compounding
Scroll back to PMT key and enter solve key as the answer flashes -600.08.
Now we can use variation just like mortgage calculators available on the web and computer
spreadsheets e.g.
1. Calculate the PV if we know how much maximum EMI can be paid

Set = End key

N = 180 periods (15 years x 12 months)
I% = 12
PV = solve key
PMT = -600.08
FV =0
P/Y =12 as the installments per year is 12 the duration of loan is 15 year
2. Calculate the maximum Rate of interest can be borne if EMI, period and PV is
known
Set = End key

N = 180 periods (15 years x 12 months)
I% = Solve key
PV = 50000
MT = -600.08
FV =0
3. Calculate the Number of periods (i.e years) wherein loan can be repaid if PV, I%
and EMI is known
Set = End key

N = Solve key
I% = 12
PV = 50000
PMT = -600.08
FV =0
4. Example
Just in simple way skip the term we want to know and enter the data in rest of the terms as
before, using the scroll key come back to the term we want to know and press solve key and
result is available.

G.Excel Application
PV
Returns the present value of an investment. The present value is the total amount that a series of future
payments is worth now. For example, when you borrow money, the loan amount is the present value to the
lender.
PV(rate,nper,pmt,fv,type)
Rate is the interest rate per period. For example, if you obtain an automobile loan at a 10 percent annual
interest rate and make monthly payments, your interest rate per month is 10%/12, or 0.83%. You would enter
10%/12, or 0.83%, or 0.0083, into the formula as the rate.
Nper is the total number of payment periods in an annuity. For example, if you get a four-year car loan and
make monthly payments, your loan has 4*12 (or 48) periods. You would enter 48 into the formula for nper.
Pmt is the payment made each period and cannot change over the life of the annuity. Typically, pmt includes
principal and interest but no other fees or taxes. For example, the monthly payments on a $10,000, four-year car
loan at 12 percent are $263.33. You would enter -263.33 into the formula as the pmt. If pmt is omitted, you must
include the fv argument.
Fv is the future value, or a cash balance you want to attain after the last payment is made. If fv is omitted, it is
assumed to be 0 (the future value of a loan, for example, is 0). For example, if you want to save $50,000 to pay
for a special project in 18 years, then $50,000 is the future value. You could then make a conservative guess at
an interest rate and determine how much you must save each month. If fv is omitted, you must include the pmt
argument.
Type is the number 0 or 1 and indicates when payments are due.
Set type equal to If payments are due
0 or omitted At the end of the period
1 At the beginning of the period
Remarks

Make sure that you are consistent about the units you use for specifying rate and nper. If you make
monthly payments on a four-year loan at 12 percent annual interest, use 12%/12 for rate and 4*12 for
nper. If you make annual payments on the same loan, use 12% for rate and 4 for nper.
The following functions apply to annuities:
CUMIPMT PPMT
CUMPRINC PV
FV RATE
FVSCHEDULE XIRR
IPMT XNPV
PMT
An annuity is a series of constant cash payments made over a continuous period. For example, a car
loan or a mortgage is an annuity. For more information, see the description for each annuity function.
In annuity functions, cash you pay out, such as a deposit to savings, is represented by a negative
number; cash you receive, such as a dividend check, is represented by a positive number. For
example, a $1,000 deposit to the bank would be represented by the argument -1000 if you are the
depositor and by the argument 1000 if you are the bank.
Microsoft Excel solves for one financial argument in terms of the others. If rate is not 0, then:
If rate is 0, then:
(pmt * nper) + pv + fv = 0
Example

A B
1 Data Description
2 500 Money paid out of an insurance annuity at the end of every month
3 8% Interest rate earned on the money paid out
4 20 Years the money will be paid out
Formula Description (Result)
=PV(A3/12, 12*A4, A2, , 0) Present value of an annuity with the terms above (-59,777.15).
The result is negative because it represents money that you would pay, an outgoing cash flow. If you are asked
to pay (60,000) for the annuity, you would determine this would not be a good investment because the present
value of the annuity (59,777.15) is less than what you are asked to pay.
NOTE The interest rate is divided by 12 to get a monthly rate. The years the money is paid out is multiplied by
12 to get the number of payments.

PMT
Calculates the payment for a loan based on constant payments and a constant interest rate.
MT(rate,nper,pv,fv,type)
For a more complete description of the arguments in PMT, see the PV function.
Rate is the interest rate for the loan.
Nper is the total number of payments for the loan.
Pv is the present value, or the total amount that a series of future payments is worth now; also known as the
principal.
Fv is the future value, or a cash balance you want to attain after the last payment is made. If fv is omitted, it is
assumed to be 0 (zero), that is, the future value of a loan is 0.
Type is the number 0 (zero) or 1 and indicates when payments are due.
Set type equal to If payments are due
0 or omitted At the end of the period
1 At the beginning of the period
Remarks
The payment returned by PMT includes principal and interest but no taxes, reserve payments, or fees
sometimes associated with loans.
Make sure that you are consistent about the units you use for specifying rate and nper. If you make
monthly payments on a four-year loan at an annual interest rate of 12 percent, use 12%/12 for rate and
4*12 for nper. If you make annual payments on the same loan, use 12 percent for rate and 4 for nper.
Tip To find the total amount paid over the duration of the loan, multiply the returned PMT value by nper.
Example 1
A B

1 Data Description
2 8% Annual interest rate
3 10 Number of months of payments
4 10000 Amount of loan
=PMT(A2/12, A3, A4) Monthly payment for a loan with the above terms (-1,037.03)
=PMT(A2/12, A3, A4, Monthly payment for a loan with the above terms, except payments are due at the
0, 1) beginning of the period (-1,030.16)
Example 2
You can use PMT to determine payments to annuities other than loans.
A B
1 Data Description
2 6% Annual interest rate
3 18 Years you plan on saving
4 50,000 Amount you want to have save in 18 years
=PMT(A2/12, A3*12, 0, A4) Amount to save each month to have 50,000 at the end of 18 years (-129.08)
NOTE The interest rate is divided by 12 to get a monthly rate. The number of years the money is paid out is
multiplied by 12 to get the number of payments.

UNIT
2
RISK ANALYSIS & INSURANCE PLANNING

A. Risk analysis
B. Review of life insurance
C. Life insurance need analysis
D. Review of non life insurance
E. Settlement of claims in insurance

A. RISK ANALYSIS
Meaning and objective of risk management
The combination of perils and hazards creates risks to which an individual is vulnerable
every day in life. These range in severity from the risk of dying to something as minor as the
risk of getting ill with a common flu bug. They also vary in likelihood from high frequency to
low-frequency risks. The chances of getting the flu at some point in the life are obviously
much greater than the chances of perishing in an airplane tragedy. But whatever its
likelihood or possible severity, every risk carries the potential for some type and degree of
loss. If an individual doesn‟t have medical insurance, even the risk of the flu can produce
financial losses in the form of doctors‟ visits and prescription drugs.
In effect, if an individual wants to minimize the losses associated with different kinds of risks,
he needs to develop a plan for dealing with risk. This plan should treat each specific risk on
an individual basis while simultaneously addressing them all together as a total package of
risks. This is where risk management comes into play.
Objective of risk management
Given the number and variety of risks that exist in the everyday world, the basic objective of
risk management should be fairly obvious. Risk management is simply intended to combat
the risks an individual faces in life and, in so doing, to minimize the financial and other losses
potentially associated with those risks.
Steps in personal risk management
Identifying
Risks
Reviewing Communication Assessing

&Reporting & Learning Risks
Risks
Managing &
Controlling
Risks
Identifying Exposure to Loss

Identifying exposures is a vital first step to risk management; until you know the scope of all
possible losses, you won't be able to develop a realistic, cost-effective strategy for dealing
with them.
It is not easy to recognize the hundreds of hazards or perils that can lead to an unexpected
loss.

For example,' unless one has experienced a fire, he may not realize how extensive fire
losses can be. Damage to the building and its contents are obvious, but also consider
I. Smoke and water damage.
II. Damage to employees' personal property and to others' property (e.g., data-
processing equipment on' lease or customers' property) left on the premises.
III. The amount of business one‟ll loses during the time it takes to return business to
normal.
IV. The potential permanent loss of customers to competitors.
The process of identifying exposures begins by taking a close look at each of the client‟s
business operations and assesses what could cause a loss. If there are dozens of
exposures one will find dozens of answers.
For each exposure that is identified, ask how serious that loss is. This question focuses on
the possible severity of each exposure, e.g., what would that loss cost? The purpose here is
not to determine the source of replacement or repair funds, but the full cost of the loss.
Many business owners use a risk analysis questionnaire or survey, available from insurance
agents, as a checklist. Agents and financial planners are expected to help analyze the
situation; with their expertise and experience, they are less .likely to overlook any exposures.
A loss exposure is the possibility of financial loss that a particular entity faces as a result of a
particular peril striking a particular thing of value. Probably the most important step in the risk
management process is the identification or finding of risks that need to be treated. If one is
not aware of the existence of a risk, one certainly cannot make plans for handling it.
In order to consider the identification of risks, it is necessary to classify them in some sort of
orderly manner. Although various methods for classifying risk can be devised, it is common
to classify risks in a manner similar to that used by the insurance industry. This system has
the advantage of making it easier to relate risks to insurance coverage‟s like
Personal risk
Property Risk
Liability Risk
Personal Risk
As the name suggests these are risks associated with an individual and below mentioned
are some of the process of looking at personal risks
I. Lifestyle
In terms of lifestyle, if an individual participates in dangerous activities such as hang
gliding or mountain climbing, he is exposing himself to risks that most individuals
don't have. Since these activities put the individual at increased risk for injury and
premature death, the individual needs to be especially concerned about the financial
losses for the dependents if something happened to him. Other lifestyle issues that
may raise similar concerns include smoking, alcohol consumption, and occupational
hazards.
II. Existing insurance

An individual's existing insurance may make it easy to pinpoint the areas where he is
vulnerable to loss and other areas and where he is not insurance is specifically
designed to safeguard against the risk of loss. Assuming the individual has carefully
chosen the type(s), coverage and amount(s) of insurance he needs and may already
have enough protection against certain kinds of losses. If so, his chance of loss in
those areas is minimal, so he can forget about them and move on to other areas, if

any, where the protection is 'not as adequate. Let's say an individual has Rs. 500,000
of life insurance coverage but no health insurance. While he may not need to worry
about how his family will get by if he prematurely dies, he should consider how he‟ll
pay the medical bills if he is suddenly down with a serious illness that's expected to
drag on for years.
Advisor relationship(s)
Equally important in identifying potential risks and losses is the relationship with financial
planner and any other advisors. The reason is simply that the better the individual and the
advisor know each other, the more familiar he or she will be with the finances, lifestyle, and
other circumstances. This greater familiarity will make it easier for the advisor to identify the
risks and potential losses that apply to a client's situation. It should also make for a more
comfortable relationship that will allow the two to candidly discuss particularly sensitive
matters (e.q., spouse's aversion to handling money) that might come into play come into
play at this stage of the risk-management process.
Property Risk
Property risks of several types are created by the possibility of property being damaged or
destroyed. The first task involves identifying that property and then determining what perils
might damage it. Losses can be divided into three categories.
 Direct Loss
 Indirect loss
 Contingent loss
 Direct Loss
A direct loss is incurred by the owner of property or the party responsible for property
when it is damaged by a peril. The property may be real property or personal
property. A loss is sustained if expenditure must be made to repair or replace the
damaged or destroyed property. Property damage can be caused by many common
perils, such as fire, windstorm, lightning and vandalism. To cope effectively with the
possibility of physical damage to property, the business owner should consider more
than just damage to or destruction of a building. Contents may be even more
susceptible. Manufacturers might lose raw materials and finished goods, and
merchants, valuable inventories and fixtures. Any business miglit lose valuable
accounting records, making it difficult to bill or collect from customers. Vital
machinery or equipment may become inoperable, and, if replacements can't be
found and installed immediately, the business may even be forced to temporarily shut
down.
 Indirect Loss
Damage to real or personal al property may cause indirect or consequential losses.
These are losses which occur when, as a result of damage to real or personal
property, income is reduced or additional expenses are incurred other than for the
repair or replacement of damaged property.
 Contingent Loss
A contingent loss may be suffered by a party who is dependent upon the activities of
another party owning or operating the property that is damaged. For example, if a
major supplier's facility is damaged, or access ·to the individual's facilities is not
possible because of a storm or other catastrophe, individual may lose income, or
incur additional expenses as a result of the storm.

Liability Risk
Liability Risk indicates losses caused by injuries to persons or liability for injuries to persons
or damage to property of others. Workers Compensation, General Liability, Auto, and similar
losses are considered casualty losses inviting liability of the person responsible.
Liability Losses
Every business faces exposure to liability losses. A business may become legally liable (i.e.
responsible for payment) for bodily injury suffered by another person or persons, or for
damage to or destruction of the property of others. This liability may be the result of
 A court decision (as in a lawsuit charging negligence).
 Statutory provisions (such as a state's workers' compensation law).
Violation of contract provisions (a contract that makes one party responsible for
certain kinds of losses).
Public Liability
A business may be held liable for injuries or other losses suffered by a member of the
general public as the result of the firm's (or its employees') negligence or fault. Examples
include
 A customer in a firm's building falls on a broken step.
 A defective product causes injury to its user.
 Improper installation of a product causes injury to a customer.
A daily newspaper provides dozens of other examples. A firm that is found legally liable for
harming a third party must pay damages to compensate the injured party. Sometimes the
court also imposes punitive damages and, in cases involving violation of statutes designed
to protect the community, the court may levy fines in order to discourage future violations.
Liability to Employees
India has enacted workers' compensation laws. These laws require most employers to
compensate employees for loss of income or medical expenses resulting from work-related
disease or injury (except for certain self-inflicted injuries). Should an employee die as a
result of a job-related accident or disease, the employee's family also collects a specified
amount.
Evaluation of Risks
Once identified, the next step in the risk management process is to evaluate risks. In order to
evaluate a risk, one must determine the probability of loss by considering the following:
a) Frequency
b) Severity
c) Variation
d) Impact
a. FREQUENCY
Frequency is a measure of how often a particular type of loss occurs or will occur.
Generally, what we experience in our life is that smaller losses occur more frequently
and larger losses less frequently, that is very much an admitted fact in all spheres.

But then each risk has to be measured and a probable frequency must be anticipated
to decide on the risk management.
Table 1: Assessing the Likelihood of the risk occurring

Likelihood level
Rare May occur only in exceptional circumstances 1

Unlikely Is unlikely to occur, but could, at some time 2
Possible Fairly likely to occur at some time, or in some circumstances 3
Likely Will probably occur at some time, or in most circumstances 4
Almost certain Is excepted to occur in most circumstances 5
b. SEVERITY
When considering the degree of risk involved, we must also consider severity-the
amount of loss that is to be sustained. To predict future losses, prior occurrences
should be reviewed to determine how often losses of a certain type have taken place,
and the range in cost of those losses. Various "trending factors" are applied to
recognize such things as inflation, changes in laws, delay in reporting claims,
increased activity, etc.
High Frequency
Area of
Priority Concern
Low Severity
High Severity
Low Frequency
c. Variation
When surveying exposures to risk and considering prior loss experience as an
indication of probable future, loss experience cannot be emphasized too strongly.
The fact that one did not had a fire at a location during the last five years does not
mean that the location will not have a fire next year. However, a high frequency of
small losses may be an indication of carelessness or poor management.
d. Impact
While risks are commonly evaluated in terms of frequency, severity and variation, the
possible impact of a loss is also an important consideration. When dealing with risks
involving damage or destruction of property, it is common to consider severity and
impact in terms of maximum possible loss (the worst that could happen) or maximum
probable toss (the worst that is likely to happen).
Usually, maximum probable loss is a more realistic measure, but this can be very
difficult to determine when large, highly valued properties are involved. Not only is it
sometimes difficult to determine the extent to which a particular property would be
damaged-by a peril, But it can also be extremely difficult to .determine the extent to
which business will be interrupted or the extra expenditures that would be required to
conduct operations at another location and expedite reconstruction of the damaged
facility.

Evaluation of liability risks is much more difficult. For the most part, the amount of a
liability claim is a matter of pure chance, although smaller losses do occur more
frequently than large losses.
For example, even though the potential losses resulting from an earthquake would
probably be far more severe than the losses associated with a shattered car
windshield, one may opt to have glass coverage on auto insurance but no
earthquake coverage on homeowners insurance. Particularly if he lives in an area
where earthquakes rarely occur, one might base these decisions on the fact that the
probability of damage to the car windshield is much higher than the probability of
earthquake damage to the home. Of course, other types of risks with the potential for
high-severity losses may be evaluated very differently than earthquakes based on
the greater likelihood that they will occur.
Alternative Risk Management Techniques
After risks have been identified and evaluated, the next step in the risk management process
is a determination of what to do about them. Risk management involves either
 Stopping losses from happening (RISK CONTROL) or
 Paying for those losses that inevitably do occur (RISK FINANCING)
OBJECTIVE-To travel from A to B in time for an important meeting

Owner Inherent assessment Contr Residual Action Tar
ols in Assessment Planne get
place d dat
e
Myself Risk Impact Likeliho Impact Likeliho
od od
Missing a High High Catch High Low No
train makes train further
me late for one action
the earlier planne
important than I d
meeting actual
ly
need
Anoth Severe High Low Cann High Low Teleph Au
er weather ot one gus
prevents the contro confer t
train from l encing
running facility
to be
installe
d as a
contin
gency

Myself Engineering High Medium Chec High Low No

works make k for further
the train late engin action
eering planne
works d
and
arran
ge
flexibil
ity
with
peopl
e I am
meeti
ng

B. Life insurance need analysis
What amount of life insurance should an individual own?
A number of methods are used to determine the proper amount of life insurance. The
difference is that the simple rule of thumb approach may be applied by the clients and
individuals of their own to get an approx idea of their requirement, but a financial planner will
be expected to work on the needs analysis employing more scientific method and industry
accepted methods to find the same. The rules of thumb are simple basic calculations. There
are more specific calculations industry adopted methods, such as the family needs
approach, income replacement approach, capital retention approach, and capital liquidation
approach, whatever approach is used, life insurance is important to provide the needed cash
to meet financial needs.
Some simple rules of thumb
 Human life Approach

 Need Approach
 Capital Needs analysis Approach
Rules of thumb
A rule of thumb is a simple guideline that can be easily applied to a situation. It gives an
instant answer to the basic need for life insurance, there are some rules of thumb that may
be used to calculate a basic amount of insurance coverage. The rules of thumb are simplistic
and do not consider many of the factors used in other methods of insurance-need
determination. They are however, easy to use and provide a starting point insurance-need
evaluation.
Common rules of thumb for determining amounts of life insurance coverage
Income rule
The most basic guideline for determining an insurance requirement is six to eight times of
the gross annual income. Under this rule, a person earning a gross salary of Rs. 60,000 per
annum, should have between Rs. 360,000 and Rs. 480,000 of life insurance
Gross Salary X6 X8
60,000 360,000 480,000
80,000 480,000 640,000
100,000 600,000 800,000
Income Plus expenses
This rule is considers gross annual income along with cash needs at death and any special
funding needs, such as private school or college tuition. Under this rule, the insurance
requirement is five times gross income plus the total of any mortgage, personal debt, final
expenses, and special funding needs, such as college funding. For example, assume the
following expenses and debt:
Expense/Cash Need Amount

Mortgage 80,000
Personal Debt 15,000

Estimated Final Expenses 15,000

Estimated College Expenses 50,000
Total 160,000
Using the expenses assumed above, insurance requirements using this rule at various gross
salary amounts are as shown:
Gross Gross Salary X 5 Expenses Insurance Required:

Salary Gross Salary X 5+Expenses
60,000 300,000 160,000 460,000
80,000 400,000 160,000 560,000
100,000 500,000 160,000 660,000
Premiums as percentage of Income
This rule calculates the amount to be spent on premiums instead of the amount of life
insurance coverage. Under this rule, 6 percent of the earning member‟s gross income plus
an additional 1 percent for each dependent should be spent on life insurance premiums.
Assuming a earning member with a nonworking spouse and two dependents, the insurance
premium allocations are as shown for various salaries:
Salary Basic Allocation 6% Dependent Allocation (3 Premium

of Salary Dependents X 1%)X
60,000 3,600 1,800 5,400
80,000 4,800 2,400 7,200
100,000 6,000 3,000 9,000
This rule of thumb, determines the percentage of the annual income to be spent on life
insurance premiums and then an individual can buy as much life insurance as he can get for
that premium amount. When considering term insurance, the percentage of income allocated
for premiums is often calculated at 2 percent or 3 percent instead of 6%.
Multiples of Salary Method
The multiples of salary method require the use of multiples of salary chart and are based on
the assumptions that the family has one income provider and that the average family can live
adequately on 75 percent of the income provider‟s salary.
Advantage of rules of thumb for determining life insurance requirement
The rules of thumb are simple and calculations can be done using a basic calculator
immediately. They are useful as a rough starting point and can point a framework to start
assessing the insurance need of an individual.
Disadvantages of rules of thumb for determining life insurance requirement
While the rules of thumb are helpful starting point, they fail to consider the needs and
circumstances of the individual. There are no considerations of the ages of the insured or the
dependents or whether the family is provided for with one income or two. There are also no
adjustments made for special circumstances, such as the expenses associated with a
special needs child or the need for liquidity for estate planning.
There are several more comprehensive methods used to calculate life insurance need.
Overall, these methods are more detailed than the rules of thumb and provide a more
complete view of total insurance needs.

[A] HUMAN LIFE APPROACH
The human life value approach aims to replace the expected future income of the insured in
case of death. Here, the insurance purchased is based on the value of the income the
insured breadwinner can expect to earn during his or her lifetime. By focusing only on a
family breadwinner's expected future earnings stream, the human life value provides a fairly
rough estimate of life insurance needs. To help make the insurance needs estimate more
accurate, the income replacement approach allows for some adjustments to the human life
value.
Therefore, the Human life value approach projects an individual's income through his
remaining working life expectancy, and then the present value is determined by means of a
discount rate.
A demonstration would help understand the calculation involved in determining the human
life value of an insured. It has various steps involved in it.
Step 1: Determine the insured person's after-tax earnings
The first step is to take the insured‟s current after-tax earnings, essentially after-tax salary.
We use after-tax rather than gross earnings because that is the amount actually available to
spend on the family's needs.
Example: Let Mr. Kumar's current annual gross salary be Rs.1 00, 000. The income tax
liability is 30 percent of the gross salary; hence his after-tax salary is Rs.70, 000. This is the
amount Mr. Kumar currently provides to his family.
Step 2: Deduct the personal expenses of the insured
In the Human life value approach, we include only that portion of the anticipated future
income that would be devoted to the family. Since a part of the insured's earnings are spent
on self-maintenance (e.g., clothing, food, and individual transportation expenses), that part
of the future income is not available to the family.
The frequent assumption is that 25 percent of the after-tax income goes for personal
expenses and the remaining 75 percent goes for family living expenses. Thus, we multiply
the expected total earnings by a family support ratio of 75 percent (or some other amount
according to the actual available percentage in each case) to reflect the percentage of
income that actually supports the family.
Example: Mr. Kumar's gross salary is Rs.1, 00,000 and his after-tax salary is Rs. 70,000. If
we go by the 25%-75% assumption, the amount devoted to his personal expenses would be
25% of Rs.70, 000. Thus we subtract Rs.17, 500 (Rs.70, 000 * 0.25) from his after-tax salary
to arrive at the amount available to the family i.e. Rs.52, 500.
Alternately, we can take the family support ratio i.e. 75% of Rs.70, 000 as well to arrive at
the amount available to the family (Rs.70, 000 * 0.75). If the personal expenses ratio is say
30%, then you use a 70 percent family support ratio instead (Rs.70, 000 * 0.70).
Step 3: Consider the number of years for which income stream is required
The future earnings stream you want to protect reflects the income that the insured will earn
over the number of future years he or she expects to work until retirement.

Example: Mr. Kumar is 35 years old and anticipates retiring at the age 60. His expected
future economic life is 25 years. The lost income stream if he died today would be for 25
years.
Step 4: Consider anticipated salary growth and inflation
The insured's income will rarely stay the same over time. Inflation and merit increases,
promotions, or other salary growth, separate from inflation are factors that will affect the
salary increase. Therefore, we need to factor in an earnings growth factor (sum of these
effects) to account for these effects on the future earnings stream.
While considering inflation, one can take the long term average inflation rate, and for salary
increases, consider the average increase in the particular industry or in general. We can use
the future inflation rate estimate for the growth factor as well.
Example: Mr. Kumar works in the software industry. Let's say, he chooses an inflation rate
of 5%. The software field sees annual salary increases ranging from 10-20%, so he takes
10% as the inflation adjusted salary growth rate. Hence the growth factor would be 15%
percent (5% + 10%).
Note that if Mr. Kumar's family wanted to just maintain the current standard of living and not
account for future merit, seniority, or other increases unrelated to inflation, he would just use
the 5 percent inflation factor as the growth factor.
Step 5: Determine the total anticipated future income for supporting the family
We can calculate the expected future income stream using the following figures:
 Current after-tax earnings multiplied by the family support ratio
 Number of years the insured expects to work
 Earnings growth factor (accounting for inflation and salary raises)
 This future income needs to be discounted in order to arrive at the present value, or
the human life value.
Step 6: Determine a discount rate for the insurance proceeds and calculate the
present value
The discount rate should reflect the after-tax investment return on the insurance proceeds
over the years. The investment of the life insurance proceeds should provide returns over
time that equal the income stream calculated in the previous step.
Various investments like stocks, bonds, post office schemes etc. offer varying average rates
of return. Figures are available for short-, medium-, and long-term average rates of return for
the different types of investments. Stocks generally offer the highest rates of return, and
significant variations exist among the different types of stock. Similarly, different types of
bonds offer different average rates of return.
Step 7: Determine the present value of the expected income stream, using the
discount rate.
In order to find the present value of the expected income, we can utilize either a formula for
calculating present value or the easier-to-use present value tables. The present value tables
give the present value of Re 1 at various rates of return for different numbers of years that
you invest. You simply take the number of years and percentage that apply to you, find the

present value in the table, and multiply it by the expected income stream figure you
determined above.
Example: Mr. Kumar has an expected income stream of Rs. 17, 28,245 for a 25-year period
and he has chosen inflation adjusted discount rate of 4%. The present value table gives a
figure of 0.375 for a 25-year investment at 4 %. Then multiply Rs.17, 28,245 by 0.375 to
come up with a human life value of Rs. 6, 48,092.
Step 8: Making adjustments to the human life value
As discussed, the human life value is not a very precise estimate of the family's actual life
insurance needs. It sometimes tends to over estimate the family's insurance needs by not
considering other family assets and sources of income that can help support the family if the
insured dies. It does not consider other investments, savings accounts etc. that can offset
some of your family's life insurance needs.
Again, it fails to account for certain large lump-sum expenses that will come up only after the
insured's death, such as final medical expenses, funeral and burial costs, estate settlement
expenses, mortgage and other debt repayment costs, and college education costs.
Step 9: Add in large lump-sum expenses
There may be huge expenses in future that are not taken into account by projecting an
income stream based on the family's current standard of living. There may be medical costs
associated with the insured's death, personal debts such as credit card debts, college loan,
automobile loans, and home loans etc. Also children may have future education costs that
aren't necessarily part of your current income needs. The income replacement approach can
adjust for these expenses by adding them on to your human life value figure.
Step 10: Considering differences in income replacement needs during different future
periods
The amount of income needed for family support may differ over time. The time after the
insured's death can be divided into different periods:
 Readjustment period
 Dependency period
 Blackout period
 Retirement period
We need to make allowances for the varying family support needs during these periods. To
account for differing family income needs during these periods, we can estimate a
percentage of the insured's income that would be necessary during the different periods.
Differences in children's dependency needs and the availability of income from the surviving
spouse .factor into the various estimates a you make.
Advantages
More accurate than the rules of thumb

The Human life value approach considers factors like inflation, salary increases, and several
factors unique to the family's situation including the breadwinner's remaining work years.
Moreover, the income replacement method provides a more accurate estimate of life
insurance needs by considering other available assets and sources of income, and some
major lump-sum expenses.
Relatively easy to understand conceptually

Although the calculations involve a number of steps, they are relatively easy to understand
conceptually. The idea of maintaining a stream of income is more straightforward than
accounting for a long list of expenses in the family needs approach.
Disadvantages
Requires more involved calculations than some other approaches

The income replacement approach calculations involve more steps than the very
straightforward rules of thumb and some other methods.
Fails to consider family's financial needs in depth

The income replacement approach generally assumes that it is sufficient to consider that
percentage of income that currently goes towards family support when anticipating the
family's future financial needs. There are some adjustments made but it does not examine
the future expenses in depth. Thus, this approach is generally less precise than the family
needs approach.
The life insurance needs analysis is only the initial part of understanding and taking life
insurance coverage. The next step is to evaluate which type of policy has to be taken
considering each person's requirement and family situations. The first decision has to be
made whether a temporary or a permanent life insurance is required. Choice has to be made
from term life insurance and its various options or whole life insurance, universal life
insurance, endowment plans etc.
Choosing the right kind of life insurance policy also involves understanding each individual
and his family's needs and goals of taking life insurance coverage. A careful and well
throughout decision will give the best benefits to the insured's family.

UNIT
3
INVESTMENT PLANNING
A. Risk return analysis

B. Asset allocation
C. Derivatives
D. Mutual fund
E. Equity valuation
F. Small saving schemes
G. Bond return & valuation

Sharpe Ratio
Sharpe's performance index gives a single value to be used for the performance ranking of
various funds or portfolios. Sharpe index measures the risk premium of the portfolio relative
to the total amount of risk in the portfolio. This risk premium is the difference between the
portfolio‟s average rate of return and the riskless rate of return. The standard deviation of the
portfolio indicates the risk. The index assigns the highest values to assets that have best
risk-adjusted average rate of return.
St = Rp – Rf
δp
Sharpe index = Portfolio average return – Risk free rate of interest

Standard deviation of the portfolio return
The details of two hypothetical funds A and B are given below
Table 1 risk and return for funds A and B

Fund Average Annual Riskless Rate of Standard St
Return interest Deviation
A 0.0879 0.05 0.829 0.0879 – 0.05
0.0829
= 0.457
B 0.1347 0.05 0.1982 0.1347 - 0.05

0.1982
= .0427
Risk and return of funds A and B

Fund „A‟ Fund “B”
δp
Fig. 1
The larger the St Better the fund has performed. Thus, A ranked as better fund because its
index .457 > .427 even though the portfolio B had a higher return of 13.47 per cent. It is
shown in Figure 1. The reason is that the fund 'B's managers took such a great risk to earn
the higher returns and its risk adjusted return was not most desirable. Sharpe index can be
used to rank the desirability of funds or portfolios, but not the individual assets. The
individual asset contains its diversifiable risk.
,.-
Treynor Measure
To understand the Treynor index, an investor should know the concept of characteristic line.
The relationship between a given market return and the fund's return is given by the
characteristic line. The funds performance is measured in relation to the market
performance. The ideal fund's return rises at a faster rate than the general market
performance when the market is moving upwards and its. rate of return declines slowly than
the market return, in the decline. The ideal fund may place its fund in the treasury bills or
short sell the stock during the decline and earn positive return. The relationship between the
ideal fund's rate of return and the
market's rate of return is given by the figure 2.
Fund's Rate of Return
F
U 30
N
D Ideal fund
S
R
E 20
T
U
R

N
10
-20 -10 0 10 20 30
Market Return
Fig. 2
The market return is given on the horizontal axis and the fund's rate of return on the
vertical axis. When the market rate of return increases, the fund's rate of return increases
more than proportional and vice-versa. In the figure 2 the fund's rate of return is 20 per cent
when the market's rate of return is 10per cent, and when the market return is -10, the fund's
return is 10per cent. The relationship between the market return and fund' return is assumed
to be linear. This linear relationship is shown by the characteristic line. Each fund establishes
a performance relationship with the market. The characteristic line can be drawn by plotting
the fund‟s rate of return for a given period against the market's return for the same period.
The slope of the line reflects the volatility of the fund's return. A steep slope would indicate
that the fund is very sensitive to the market performance. If the fund is not so sensitive then
the slope would be a slope of less inclination.
All the funds have the same slope indicating same level of risk. The investor would prefer A
fund, because it offers superior return than funds C and B for the same level of risk
exposure. This is shown in [Figure 3]
With the help of the characteristic line Treynor measures the performance of the fund. The
slope of the line is estimated by
Rp = ά + β Rm + ep
Rp = Portfolio return
Rm= the market return or index return
ep = The error term or the residual
ά,β = Co-efficient to be estimated

Market return and funds return
40
Funds return A
30
B
20
C
10
-30 -20 -10 10 20 30 40 50 60

Market return
-10
-20
-30
-40
Fig. 3
Beta co-efficient is treated as a measure of undiversifiable systematic risk.
Tn = Portfolio average return- riskless rate of interest

Beta co- efficient of portfolio
Tn = Rp - Rf
βp
Treynor's risk premium of the portfolio is the difference between the average return and the
riskless rate of interest. The risk premium depends on the systematic risk assumed in a
portfolio. Let us analyse two hypothetical funds.
Table 2 Funds A and B
Fund Average Beta Risk return Rf Tn

return

A 0.0879 0.499 0.0379 0.05 0.0879 –

0.05
.499
=0.076
B 0.1347 1.2493 0.0847 0.05

.1347 - .05
1.2493
=0.0678
Performance of Funds ‘A’ and ‘B’
Fund „A‟
8
0.76
Fund „B‟
0.68
Rf 5.0
0.5 1.0 1.5 δp
Fig. 4
The fund 'A' is more desirable than B because it earned more risk premium per unit of
systematic risk
i.e Tn of A .076 > .0678 of 'B's.

A. Derivatives
A. Essential Features
Hedging
We have seen how one can take a view on the market with the help of index futures. The
other benefit of trading in index futures is to hedge your portfolio against the risk of trading.
In order to understand how one can protect his portfolio from value erosion, let us take an
example.
Stocks carry two types of risk- Company specific and market risk. Company specific risk can
be reduced through diversification while market risk is reduced through hedging.
Beta is the measure of market risk. Beta measures the relationship between movements of
the index to the movement of the stock. The beta measures the percentage impact on the
stock prices for 1% change in the index. Therefore, for a portfolio whose value goes down by
11% when the index goes down by 10%, the beta would be 1:1. When the index increases
by 10%, the value of the portfolio increases 11%. The strategy of hedging is resorted to with
the objective of reducing portfolio beta to zero and reducing the market risk.
Hedging involves protecting an existing equity portfolio from future adverse price movements
in the stock market. In order to hedge the portfolio, a market player needs to take an equal
and opposite position in the futures market to the one held in the cash market. Every
portfolio has a hidden exposure to the index, which is denoted by the beta. Assuming you
have a portfolio of Rs. 20 lacs, which has a beta of 1.2, you can factor a complete hedge by
selling Rs. 24 lacs of S&P CNX Nifty Futures.
Steps in hedging:
1) Determine the beta of the portfolio. If the beta of any stock is not known, it is safe to
assume that it is 1.
2) Short sell the index in such a quantum that the gain on a unit decreases in the index
would offset the losses on the rest of his portfolio. This is achieved by multiplying the
relative volatility of the portfolio by the market value of his holdings.
Therefore in the above scenario, we have to short sell 1.2*20 lacs-24 lacs worth of Nifty.
Now, lets us study the impact on the overall gain/loss that accrues:
Index goes up by 10% Index goes down by 10%
Gain/(loss) in portfolio 2,40,000 (2,40,000)
Gain/(loss) in futures (2,40,000) 2,40,000
Net effect NIL NIL
As we see, that portfolio is completely insulated from any losses arising out of a fall in
market sentiment. But as a cost, one has to forego any gain that arises out of improvement
in the overall sentiment. Then, why does one invest in equities in all the gains will be offset
by losses in future market? The idea is that everyone expects his portfolio to outperform the
market. Irrespective of whether the market goes up or not, his portfolio value would increase.
The same methodology can be applied to a single stock by deriving the beta of eh scrip and
taking a reverse position in the futures market.

Thus, we have seen how one can use hedging in the futures market to offset losses in the
cash market.
Speculation
Speculations are those who do not have any position in which they enter in futures and
options market. They only have a particular view on the market, commodity, etc. In short,
speculations put their money at risk in the hope of profiting from an anticipating price
change. They consider various factors such as demand supply, market positions, open
interests, economic fundamentals and other data to take their positions.
Example:
Kirti is a trader but has no time to track and analyze stocks. However, he fancies his
chances I predicting the market trend. So, instead of buying different stocks he buys nifty
features.
On September 1, 2009 he buys 100 nifty futures @3400 on expectations that the index will
rise in future. On September 16, 2009 Nifty rises to 3460 and at that time he sells Nifty
futures and squares his position.
Selling price: 3460*100= Rs. 346000
Less: Purchase cost: 3400*100= Rs. 340000
Net gain= Rs. 6000
Kirti has made a profit of Rs. 6000 by taking a call on the future value of the Nifty. However,
if Nifty had fallen he would have made a loss.
Similarly, if Kirti had a bearish view on the market he could have sold Nifty futures and
bought the same back after the expected market fall and made a profit from a falling market.
Arbitrage
An arbitrage is basically risk averse. He enters into those contracts where he can earn risk
less profits. When markets are imperfect, buying in one market and simultaneously selling in
other market gives risk less profit. Arbitrageurs are always on the look out for such
imperfections.
In the future market, one can take advantages of arbitrage opportunities by buying from
lower prices market and selling at the higher priced market. In index futures, arbitrage is
possible between the spot market and the future market (NSE has provided special software
for buying all 50 Nifty stocks in the spot market)
 Take the case of the NSE Nifty.

 Assume that Nifty is at 3400 and 3 month‟s Nifty futures is at 3500.
 The futures price of Nifty futures can be worked out by taking the interest cost of 3
months into account.
 If there is a difference then arbitrage opportunity exists.
If we assume 8% interest rate then Nifty three months futures should be quoting at Rs. 3468
but is actually quoting at Rs. 3500, which is higher than the correct price thus providing an
arbitrageur an opportunity-he will sell 3 months futures at 3500 and buy spot at 3400 and

should make Rs. 32 per Nifty because of the difference between the actual price and the
correct price.
These kinds of imperfections continue to exist in the markets but one has to be alert to the
opportunities as they tend to get exhausted very fast.
Pricing of index futures
The index futures are the most popular futures contracts as they can be used in a variety of
ways by various participants in the market.
The cost of carry Model
The cost of carry model where the price of the contract is defined as:
F= S+C
Where, F= Future price, S= Spot price, C= Holding costs or carry costs
If F< S+C or F>S+C, arbitrage opportunities would exist i.e. whenever the future prices
moves away from the far value, there would be chances for arbitrage.
If Nifty is quoting at Rs. 3400 and the 3 months future of Nifty is Rs. 3500 then one can
purchase Nifty at Rs. 3400 in spot by borrowing @ 8% per annum for 3 months and sell Nifty
future for 3 months at Rs. 3500.
Here F= 3400+68= 3468 and is less than prevailing future price and hence, there are
chances of arbitrage.
Sale= 3500
Cost= 3400+68= 3468
Arbitrage Profit= 32
However, one has to remember that the components of holding cost vary with contracts on
different assets.
Futures pricing in case of dividend yield
We have seen how we have to consider the cost of finance to arrive at the futures index
value. However, the cost of finance has to be adjusted for benefits of dividends and interest
income. In the case of equity futures, the holding cost is the cost of financing minus the
dividend returns.
Example
Suppose a stock portfolio has a value of Rs. 100 and has a annual dividend yield of 3%
which is earned throughout the year and finance rate is 12%.The fair value of the stock index
portfolio after one year will be:
F= Rs. 100+Rs. 100* (0.12-0.03)
Future price-Rs. 109

If the actual future price of one year contract is Rs. 112 an arbitrageur can buy the stock at
Rs. 100, borrowing the fund at the rate of 12% and simultaneously at Rs. 112. At the end of
the year, the arbitrageur would collect Rs. 3 for dividends, deliver the stock portfolio at Rs.
112 and repay the loan of Rs. 100 and interest of Rs. 12.
The net profit would be Rs. 112+Rs. 3-Rs. 100-Rs. 2= Rs. 3
Thus, we can arrive at the fair value in the case of dividend yield
Options
The markets are volatile and huge amount of money can be made or lost in very little time.
Derivatives products are structured precisely for this reason- to curtail the risk exposure of
an investor. Index futures and stock options are instruments that enable an investor to hedge
his portfolio or open positions in the market. Options contracts allow an investor to run his
profits while restricting his downside risk.
Apart from risk containment, options can be used for speculation and investors can create a
wide range of potential profit scenarios.
What are options?
Some people remain puzzled by options. The trust is that most people have been using
options for some time, because options are built into everything from mortgages to
insurance.
An option is a contract, which gives the buyer the right, but not the obligations to buy or sell
shares of the underlying security at a specific price on or before a specific date.
„Option‟ as a word suggest, is a choice given to the investor to either honour the contract; or
not if the chooses to walk away from the contract.
To begin, there are two kinds of options; Call option and put options.
A Call Option is an option to buy a stock at a specific price on or before a certain date. In
this way, call options are like security deposits. If for example, you wanted to rent a certain
property, and left a security deposit for it, the money would be used to insure that you could,
in fact, rent that property at the price agreed upon when you returned. If you never returned,
you would give up your security deposit, but you have no other liability. Call options usually
increases in value as the value of the underlying instrument rises.
When you buy a Call option, the price you pay for it, called the option premium, secures your
right to buy that certain stock at a specified price called the strike price. If you decide not to
use the option to buy the stock, and you are not obligated to, your only cost is the option
premium.
Put options are options to sell at a specific price on or before a certain date. In this way, put
options are like insurance policies.
If you buy a new car and then buy auto insurance on the car, you pay a premium and are,
hence, protected if the car is damaged in an accident. If this happens, you can use your
policy to regain the insured value of the car. In this way, the put option gains as the value of
the underlying instrument decreases. If all goes well and the insurance is not needed, the
insurance company keeps your premium in return for taking on the risk.

With a Put option, you can “issue” a stock by fixing a selling price. If something happens
which causes the stock price to fall, and thus, “damages” your asset, you can exercise your
option and sell it at its “insured” price level. If the price of your stock goes up, and there is no
“damage”, then you do not need to use the insurance, and, once again, your only cost is the
premium. This is the primary function of listed options to allow investors ways to manage
risk.
Technically, an option is a contract between two parties. The buyer receives a privilege for
which he pays a premium. The seller accepts an obligation for which he receives a fee.
Example
Now let us see how one can profit from buying an option. Mr. Shah Feels that the market will
go up. He is bullish on Nifty but he does not want to lose money if he is turned wrong and if
the market goes down.
 He buys an options contract September 2006 Nifty for a strike price of 3450 paying a
premium of Rs. 50.
 In about 15 days time Nifty goes up and therefore he sell the option for Rs. 75
making a profit of Rs. 25 per Nifty.
 The contract size being 100, he will make a profit of Rs. 25*100= Rs. 2500/-.
 If he had not sold and if the Nifty had gone up further, he would have made ever
more profits.
 If the Nifty were to fall, his maximum loss would have been restricted to Rs. 50*100=
Rs. 5000/- which is the premium paid by him for having bought the cal, option.
 Thus, you can see that the profit potential in a call option is unlimited while the loss is
limited to the actual premium paid.
Call Options –Long & short Positions
When you expect prices to rise, then you take a long position by buying calls. You are
bullish.
When you expect prices to fall, then you take a short position by selling calls. You are
bearish.
Put Options
A put option gives the holder the right to sell a specific number of shares of an agreed
security at a fixed price for a period of time.
Example
Mr. Dutt purchases one contract of infoysys technologies September 2006 1800 put-
premium Rs. 50 (contract size 100 Shares)
This contract allows Mr. Dutt to sell 100 shares infoysys technologies at Rs. 1800 share at
any time between the current date and the expiry of September 2006 series. To have this
privilege, Mr. Dutt pays a premium of Rs. 5000 (Rs. 50 a share for 100 shares).
He will make a profit if the share price of infoysys technologies falls during this period. He
has the potential to make high profits as there is a potential for the stock price to fall by any

amount but in case the price of the share goes up, he will suffer a loss but the loss will be
limited to Rs. 5000/- premium paid by him. For purchasing the right to sell (buy a put option).
The buyer of a put has purchased a right to sell. The owner of a put option has the right to
sell.
Put Options- Long & Short Positions
When you expect prices to fall, then you take a long position by buying puts. You are
bearish.
When you expect prices to rise, then you take a short position by selling puts. You are
bullish.
The following table wills summaries the actions to be taken depending upon your view on the
stock price:
Your view/Type of option Call option Put Option

You expect fall in prices Sell Buy
(bearish)
You expect fall in prices Buy Sell
(bullish)
Summary:
CALL OPTION BUYER CALL OPTION WRITTER (SELLER)

Pays the premium Receives the premium
Right to exercise and buy the shares Obligation to sell shares if exercised
Profits from rising prices Profits from falling prices or remaining
stable premium
Limited losses potential to earn unlimited Potentially unlimited losses, limited gains
premium profits
PUT OPTION BUYER PUT OPTION WRITTER (SELLER)

Pays the premium Receives the premium
Right to exercise and buy the shares Obligation to sell shares if exercised
Profits from falling prices Profits from falling prices or remaining
stable
Option Styles
Settlement of options is based on the expiry date. However, there are three basic styles of
options you will encounter which effect settlement. The styles have geographical names,
which have nothing to do with the location where a contract is agreed. The styles are:
European: These options give the holder the right, but not the obligation, to buy or sell the
underlying instrument only on the expiry date. This means that the option cannot be
exercised early. Settlement is based on a particular strike price at expiration. Currently, in
India only index options are European nature.

Example: Mr. Dutt. Purchases 1 Nifty September 2006 6450 call-premium 20. The
exchange will settle the contract on the last Thursday of August. Since there are no shares
for the underlying, the contract is cash settled.
American: These options give the holder the right, but not the obligation, to buy or sell the
underlying instrument on or before the expiry date. This means that the option can be
exercised early. Settlement is based on a particular strike price at expiration.
Options in stocks that have been recently launched in the Indian Market are “American
Options” while the options on the index are “European Options.”
Example: Mr. Patel purchases 1 Tata Steel September 06-520 call, premium 20
Here Mr. Patel can close the contract any time from the current date till the expiration date,
which is the last Thursday of September
American style options tend to be more expensive than European style because they offer
greater flexibility to the buyer.
Option Class& Series
Generally, for each underlying, there are a number of options available: For this reason, we
have the terms “class” and “series”.
An option “class” refers to all options of the same type (call or put) and style (American or
European) that also have the same underlying.
Example: All Nifty call options are referred to as one class.
An option series refers to all options that are identical: they are the same type, have the
same underlying, the same expiration date and the same exercise price.
Example: ACC SEP 2006 900 refers to one series and trades take place at different
premiums

B. Small Savings Schemes
Small is big, at least with small savings in India. Over the years, small savings schemes
have become a favorite of Indian household. Such is the popularly of these schemes that it
will probably be difficult to find an investing household not having any investment is small
savings schemes.
Small savings schemes are designed to provide safe & attractive investment options to the
public and at the same time to mobiles resources for development. Traditionally schemes
like public provident fund and National Saving Certificate have been associated with
attractive returns and tax benefits. Most importantly these schemes offer assured returns
thereby appealing to a large section of the investor community.
National Savings Organization (NSO) is responsible for national level promotion of small
savings scheme. Over the years small savings scheme has grown big.
These schemes are primarily meant for small urban and rural investors. Institutions are not
eligible to invest in major small savings schemes. Non- residential Indians (NRIs) are also
not eligible to invest in savings schemes.
The following schemes come under small savings schemes:-

 Post office Savings Account
 Post office time Deposit Account
 5 years post office Recurring Deposit Account
 Kisan Vikas Patra
 National Savings Certificate (VIII issue)
 Post office Monthly Income Account
 15 years Public Provident Fund Account
 Deposit Scheme for retiring Govt. Employees.
 Deposit Scheme for Retiring Employees of public Sector Companies 1991
1. Post office Savings Account

 Post office savings accounts can be opened by any of the following:
a. For a single account any individual who is 18 years and above, a minor who has
attained the age of 10 years, a guardian on behalf of a minor and guardian of a
person of unsound mind.
b. A joint account of two-three adults jointly.
c. A pensioner to receive/credit his monthly pension.
d. Group Accounts by provident fund, Superannuation fund or gratuity fund.
e. Public accounts by a local authority/body.
f. An employee, contractor, or agent of a government company or of a university for
depositing security amounts.
g. A Gazettled officer or an officer of a government company or corporation of
Reserve Bank of India or of a local authority in his official capacity.
h. A corporative society or a cooperative bank for payment of pay, leave salary,
pension contribution of government servants on deputation with such society or
bank.
 It can be opened at any Head/Sub post office.

 Account can be opened with a minimum of Rs. 20. However, the balance that can be
kept is the maximum of rupees one lakh for single holder and Rs. Two lakhs for joint
holders. If depositors have more than one account (single, pension or joint), the

balances or shares of balances in all such accounts taken together should not
exceed Rs. One lakh for each of the depositors.
 There is no lock-in/maturity prescribed.
 Withdrawals can be for any amount subject to keeping a minimum balance of Rs. 50
in simple and Rs. 500 for cheque facility accounts. No withdrawal or deposit can be
for a sum of less than Rs. 5.
 Interest according to the rate (s) as decided by the central Government from time to
time is calculated on monthly balances and credited annually.
 Interest rate applicable w.e.f. 1.3.2001 is 3.5 per cent/per annum for general public.
 Interest income exempted from Income tax u/s 10 of IT Act 1961.
2. Post office time Deposit Account
 The following are permitted to open post office time deposit accounts:
a. A single adult or two adults jointly.

b. A pensioner to receive/credit his monthly pension.
c. Group accounts by provident fund, Superannuation fund or Gratuity fund,
Authority controlling funds of the Sanchakiya.
d. Public account by a local authority/body.
e. Institutional Accounts by the treasurer of charitable Endowments for India, Trust
Regimental fund & Welfare Fund.
f. A corporative society. Cooperative bank or scheduled bank on behalf of its
members, clients or employees.
g. Gazetted officer in his official capacity.
 It can be opened in any head/ sub post office.

 The size of the deposit is minimum of Rs. 200 with no maximum limit.
 The maturity period can be for any of the following tenors; 1 year, 2 years, 3 years, or
5 years.
 Interest is calculated on quarterly compounding basis but is payable annually.
 At present the rate of interest per annum as per the period of deposit is as follows:
Period of Deposit Rate of Interest/annum

One year 6.25%
Two year 6.50%

Three year 7.25%
Five Year 7.50%
 Premature withdrawals from all types of post office Time Deposit accounts are
permissible after expiry of 6 months with certain conditions.
 Post maturity interest “at the rate applicable to the post office savings from time to
time”, is payable for a maximum period of 2 years.
 There is no tax deduction at source.
 Income tax benefit is available under section 80C.
3. Post office Recurring Deposit Account
 The following can open a post office recurring deposit account:-

a. A single adult or two adults jointly.
b. A guardian on behalf of a minor or a person of unsound mind.
c. A minor who has attained the age of ten year, in his own name.

 It can be opened at any head/sub post office.

 The period of maturity of an account is five years.
 Sixty equal monthly deposits shall be made in an account in multiples of Rs. Five
subject to a minimum of ten rupees.
 Accounts with not more four defaults in deposits can be regularized within a period of
two months on payment of a default fee.
 Accounts become discontinued after more than four defaults.
 To a subscriber of Rs. 10 per month the maturity amount inclusive of interest shall be
Rs. 728.90 (accounts opened after 1st March 2003).
 Premature closure of accounts is permissible after expiry of three years provided that
interest at the rate applicable to the post office savings account shall be payable on
such premature closure of account.
 After maturity the maximum it can be extended for five years.
4. Post office Monthly Income Account
 Can be opened by a single adult or 2-3 adults jointly.

 More than one account can be opened subject to maximum deposit limits.
 Can be opened at any head/sub post office.
 The period of maturity is 6 years.
 Only one deposit can be made in an account.
 Minimum size of a deposit is Rs. One thousand and the maximum is rupees three
lakhs in case of single and rupees six lakhs in case of joint account. Deposits in all
accounts taken together shall not exceed Rs. Three lakhs in single account and Rs.
Six lakhs in joint account. The depositor‟s shares in the balances of joint accounts
shall be taken as on half or one third of such balance according as the account is
held by 2 or 3 adults.
 Interest @ 8 per cent/per annum, payable monthly in respect of the accounts opened
on or after the 1st march, 2003. In addition, bonus equal to five per cent of the
deposited amount is payable at the time of repayment on maturity.
 Premature closure facility is available after one year subject to condition.
 Account shall be closed after expiry of 6 years; bonus equal to five per cent of
deposits shall be paid along with principal amount.
5. National Savings Certificate (VIII issue)
 National Savings certificate can be purchased by the following classes of persons:
a. An adult in his own name or on behalf of a minor.

b. A minor
c. A trust
d. Two adults jointly
e. Hindu undivided family.
 It is available for purchase/issue at post offices.
 The period of maturity of a certificate is six years.
 Nomination facility is available.
 Certificates can be transferred from one post office to any other post office.
 Transfer from one person to another person permissible in certain conditions.
 Certificates are available in denominations (face value) of Rs. 100, Rs. 500, Rs.
1000, Rs. 5000 & Rs. 10000. There is no maximum limit for purchase of the
certificates.
 With effect from 1st March, 2003, Maturity value of a certificate of Rs. 100 domination
is Rs. 160.10. Maturity value of a certificate of any other denomination shall be at
proportionate rate. The stated rate of interest is 8% p.a.

 Interest accrued on the certificates every year is liable to income tax but deemed to
have been reinvested. The investment is eligible for rebate u/s 80C of IT Act. Annual
accrued interest is also eligible for rebate U/s 80C of IT Act 1961.
 Premature encashment of the certificate is not permissible except at a discount in the
case of death of the holder(s), forfeiture by a pledge and when ordered by a court of
law.
 In can be encashed/discharged at the post office where it is registered or any other
post office.

C. BOND RETURN AND VALUATION
Debt instruments are the cherished conduit for investor's money. An assured return and high
interest rate are responsible for the preference of bonds over equities. The year 1996-97
witnessed hectic trading in the debt market, as resource mobilisation reached a record level
of almost Rs 25,000 crores which is much above the equity segment. In the first seven
months of the fiscal year 1998-99, the funds mobilised by ICICI (Four debt issues) and IDBI
have accounted for 90 per cent of Rs. 3175 crores mopped in primary market. Financial
institutions, banks and corporate bodies are offering attractive bonds like retirement bonds,
education bonds, deep discount bonds, encash bonds, money multiplier bonds and index
bonds. In this chapter the risk, the yield to maturity the duration and bond immunization is
given in detail.
BOND BASICS
A bond is a contract that requires the borrower to pay the interest income to the lender. It
resembles the promissory note and issued by the government and corporate. The par value
of the bond indicates the face value of the bond i.e. the value stated on the bond paper.
Generally, the face values of bonds are Rs 1, 000, 2000, 5,000 and alike. Most of the bonds
make fixed interest payment till the maturity period. This specific rate of interest is known as
coupon rate. Coupons are paid quarterly, semi-annually and annually. At the end of maturity
period, the value is repaid.
Bond risk
Generally stocks are considered to be risky but bonds are not. This is not fully correct.
Bonds do have risk but the nature and types of risks may be different. The risks are interest
rate, default, marketability, and callability risks.
Interest rate risk
Variability in the return from the debt instruments to investors is caused by the changes in
the market interest rate. This is known as interest rate risk. Changes that occur in interest
rate affect the bonds more directly than the equity. There is a relationship between the
coupon rate and market interest rate. If the market interest rate moves up, the price of the
bond declines and vice versa. For example, If one holds a 14.50 per cent bond and the
market interest rate falls, from 14per cent to 13 per cent, the bond value would be higher. In
contrast, if the market interest rate goes upto 15 per cent, the price would decline to offer the
buyer a yield that is proximate to the market interest rate.
Default risk The failure to pay the agreed value of the debt instrument by the issuer in full,
on time or both are the default risk. Treasury bills and bonds issued by the Central
Government are devoid of this risk. The same cannot be assured of bonds/debentures
issued by any other corporate bodies. The default risk occurs because of macro economic
factors or firm specific factors. The macro economic factors affect the overall system. A
number of small firms found the going difficult in 1995-96 because of high interest rates in
1994 and 1995. In the case of CRB Capital Market, the bankruptcy had more to do with the
firm specific factors - inefficient management rather than macro economic factors.
In order to avoid the default risk, the capacity to serve the debt by the company is rated by
rating agencies. Regulators like: Reserve Bank of India and Securities and Exchange Board
of India often use credit rating to determine the eligibility of the fixed income instruments.
Credit Rating Information Services of India Limited (CRISIL), Investment Information and
Credit Rating Agency of India Limited (ICRA) and Credit Analysis and Research Limited

(CARE) are rating the bonds and other fixed income securities. In the international bond
market, Moody's Investor Service and Standard and Poor's ratings are famous.
Marketability risk Variation in return caused by the difficulty in selling the bonds quickly
without
having to make a substantial price concession is known as marketability risk. This risk is
different from the market risk that affects all securities in the market but, marketability risk is
a specific risk. The marketability or liquidity of the particular bond depends on the corporate
who issues the bond. There is a possibility of a particular company's bond becoming illiquid
due to the down-grading of bond's rating by the rating agencies. The managerial
inefficiencies and fall in the profits may create a fear in the minds of the investors and they
may not be willing to buy such bonds in the secondary market. Sometimes, a particular
instrument of a company whose other instruments enjoy good liquidity may be illiquid. If an
investor has to sell such illiquid investments, he may be forced to sell it at a high discount.
For example, the bonds/debentures issued by Reliance Industries enjoy high liquidity, but
the same may not be true of the debentures issued by the smaller companies. Thus liquidity
of the particular bond or debenture depends on the corporate image.
Callability risk The uncertainty created in the investor's return by the issuer's ability to call
the bond at any time is known as call ability risk. Debt instruments used to carry call option.
The call option provides the issuer the right to call back the instruments by redeeming them.
This facility provides a way out for the issuer if the interest rate declines. The issuer can call
the bond with high interest rate and again raise funds at a lower interest rate. Since, the
bond or debenture can be called at any time there is an uncertainty regarding the maturity
period. This feature of the bond may depress the price level of the bond and the uncertainty
element attached with the callable bonds make the investors to ask for higher yields.
THE TIME VALUE CONCEPT
The time value concept of money is that the rupee received today is more valuable than a
rupee received tomorrow. The investor will postpone current consumption only if he could
earn more future consumption opportunities through investment. Individuals generally prefer
current consumption to future consumption. If there is inflation in the economy, a rupee
today will represent more purchasing power than a rupee at a future date.
Interest is the rent paid to the owners to part their money. The interest that the borrower
pays to the lender causes the money to have future value different from its present value.
The time value of money makes the rupee invested today grow more than a rupee in the
future. To quantify this concept mathematically compounding and discounting principles are
used. The one period future time value of money is money is given by the equation:
Future value= Present Value (1 + interest rate). If hundred rupees are put in a savings bank
account in a bank for one year, the future value of money will be:
Future Value = Rs 100 (1.0+6%)

= 100 x 1.06 = Rs 106.
If the deposited money is allowed to cumulate for more than one time, the period exponent is
added to the previous equation.
Future Value = Present Value (1 + interest rate) t
t - the number of time periods the deposited money accumulates as interest. Suppose Rs
100 is put for two years at the 6% rate of interest, money will grow to be Rs 112.36.

Future value = (Present Value) (1 + interest rate) 2
= 100 (l + .06)2
= 100 (1.1236)
= 112.36.
To find out the values in a simple manner, the compound sum of Re.1 at the end of a period
FVIF1, /K, n and compound sum of an annuity of Re.1 per period FVIFA tables are given in
the appendix 1.
THE PRESENT VALUE
The present value of money can be found simply by reversing the earlier equation.
Present value X (1 + interest rate) = Future value
Present value=Future value

1+ interest rate
Here, the discounting principle is used. Today's worth of Rs 100 to be received after a year
at 10 per cent interest would be:
Present value =Future value

1+ interest rate
Here, the discounting principle is used. Today‟s worth of Rs. 100 to be received after a year
at 10% interest would be:
Present value =Future value

1+ interest rate
=100__ = 100
1+.10 1.1
=Rs.90.90
The multiple period of present value equation takes in to account of the multiple periods.
Present value=Future value

(1+ interest rate) t
To make the calculation easier, the present value ofRe.1: PVIF ==1/ (1 +K) t and present
value of annuity of Re.1 per period.
BOND RETURN
Holding period return An investor buys a bond and sells it after holding for a period. The
rate of return in that holding period is:
Price gain or loss during the holding

Holding period return = Period + Coupon Interest rate , if any
Price at the beginning of the holding period

The holding period rate of return is also called the one period rate of return. This holding
period return can be calculated daily or monthly or annually. If the fall in the bond price is
greater than the coupon payment the holding period return will turn to be negative.
Example 10.1
a) An investor 'A‟ purchased a bond at a price of Rs 900 with Rs 100as coupon

payment and sold it at Rs 1000. What is his holding period return?
b) If the bond is sold for Rs 750 after receiving Rs 100 as coupon payment, then what
is the holding period return?
Solution
(a)
Holding period return = Price gain + coupon payment =
Purchase price
=100 + 100 = 200 = .2222

900 900
Holding period return =22.22 %
(b)
Holding period return = Gain or loss + Coupon payment
Purchase price
= -150+100 = -50 =-.0555

900 900
Holding period return = -5.5%.
The current yield The current yield is the coupon payment a~ a percentage of current
market price,
Annual coupon payment
Current yield =-----------------------------------------
Current market price
With this measure the investors can fmd out the rate of cash flow from their investments
every year. The current yield differs from the coupon rate, since the market price differs from
the face value of the bond. When the bond's face value and market price are same, the
coupon rate and the current yield would be the same. For example, when the coupon
payment is 8% for Rs.l00 bond with the same market price, the current yield is 8%. If the
current market price is RS.80 then the current yield would be 10%.

Roots Institute of Financial Markets

(RIFM)
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NCFM Modules Practice Books (about 500 Questions per Module)
Cost ` 600 Per Module

1. FINANCIAL MARKETS: A BEGINNERS MODULE
2. SECURITIES MARKET (BASIC) MODULE
3. CAPITAL MARKET (DEALERS) MODULE
4. DERIVATIVES MARKET (DEALERS) MODULE
5. COMMODITIES MARKET MODULE
6. INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT
7. OPTION TRADING STRATEGIES
NISM Modules Practice Books (about 500 Questions per Module)

Cost ` 600 Per Module
1. MUTUAL FUND DISTRIBUTORS CERTIFICATION EXAMINATION
2. CURRENCY DERIVATIVES CERTIFICATION EXAMINATION
CFP Certification Modules ---Study Notes (Detailed Study notes as

per FPSB syllabus) Cost ` 1000 Per Module
1. INTRODUCTION TO FINANCIAL PLANNING
2. INVESTMENT PLANNING
3. RISK ANALYSIS OF FINANCIAL PLANNING
4. RETIREMENT PLANNING
5. TAX PLANNING
CFP Certification Modules ---Practice Books (about 800 Questions

per Module) Cost ` 1000 Per Module
1. INTRODUCTION TO FINANCIAL PLANNING
2. INVESTMENT PLANNING
3. RISK ANALYSIS OF FINANCIAL PLANNING
4. RETIREMENT PLANNING
5. TAX PLANNING
Advance Financial Planning Module---
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Roots Institute of Financial Markets

i Roots Institute of Financial Markets

Roots Institute Of Financial Markets Is An Advanced Research Institute Promoted By

We Are Constantly Engaged In Providing A Unique Educational Solution Through

Wish You Luck……………

Faculty And Content Team, RIFM

ii Roots Institute of Financial Markets

CA. Ravi Malhotra

Vipin Sehgal CFPCM

Neeraj Nagpal CFPCM

3 Roots Institute of Financial Markets

Module I Module II Module III Module IV Module V

practiced in most international professional certification examinations. However, given the

Grade Score (Percentage)

A Equal and above 75%

B Equal and above 60% and less than 75%

C Equal and above 50% and less than 60%

Fail Less than 50%

4 Roots Institute of Financial Markets

Advanced Financial Planning

DETAILED CLASS OUTLINE:

Financial Planning Process

1. Establishing client- planner relationships

2. Gathering client data and determining goals and expectations

5 Roots Institute of Financial Markets

a. Divorce / remarriage considerations

a. Life insurance needs and current coverage

a. Current retirement plan tax exposures

a. Available employee benefits

6 Roots Institute of Financial Markets

a. Estate planning documents

4. Analyze Client Objectives, Needs and Financial Situation

a. Analysis of relevant information

5. Developing and presenting the Financial Plan

3. Capital needs at retirement

7 Roots Institute of Financial Markets

c. Projections with recommendations

4. Capital needs projections at death

5. Capital needs: disability

6. Capital needs: General needs

7. Capital needs: special needs

10. Asset allocation

8 Roots Institute of Financial Markets

c. Policy statement with recommendations

13. List of prioritized action items

a. Presenting and reviewing the plan with the client

6. Implementing the Financial Plan

a. Assist the client in implementing and recommendations

7. Monitoring the Financial Plan

a. Monitor and evaluate soundness of recommendations

a. Internet usage and application

9. Foreign exchange issues for individuals

a. Foreign Exchange Management Act (FEMA)

10. Financial Planning for special needs and clients

9 Roots Institute of Financial Markets

a. Individual life cycle

10 Roots Institute of Financial Markets

11 Roots Institute of Financial Markets

INTRODUCTION TO FINANCIAL PLANNING

A. Financial planning process

12 Roots Institute of Financial Markets

A. TIME VALUE OF MONEY

Calculate and interpret time value of money

Solution: Real rate= 1+nominal rate/1+inflation rate-1100= 1.0725/1.0350-1100= 3.62%