MONEY SIMPLIFIED

AN INTRODUCTION TO FINANCIAL MARKETS

AND PRODUCTS
 PROGRAM OBJECTIVES
At the end of the program, you will be able to:

 Have an over-all view of the financial markets and their function

 Understand main concerns of an investor and risk-return trade-off
 Appreciate the nature of the equity/ debt markets and products
 Know about the government sponsored saving plans
 Understand the role of interest in debt markets
 Appreciate what mutual funds are and how they function
 Understand Unit-linked plans vs. Mutual Funds
 Grasp certain practical aspects of investing:
• Fixed returns vs. Market related returns
• Early investing and Magic of compounding
• Rupee cost averaging
• Long term vs. Short term investment
• Nominal vs. Real rate of interest
 Interpret financial events & data and explain them to our customers
 Handle objections effectively

2
 MONEY

Our customers have different financial goals: a

house, a car, children’s education, corpus for old
age, etc., and a need for family protection
But to all these ends, means is
MONEY
Money earned wisely, Money saved regularly and
Money invested smartly
To help the customer plan his personal finances, our
advisors need to understand the big picture of
financial system
3
 FINANCIAL MARKETS

Financial markets can be broadly categorized into:

 
1. Capital market
2. Money market
3. Foreign exchange market

4
 CAPITAL MARKET

Capital market is concerned with:

– The demand, and
– The supply of long term funds

The demand comes from corporates, business firms,

government bodies (for equity and debt)
The supply comes from households (savings),
corporates (internal accruals, investments), trusts,
etc.
Capital market instruments : equity, debt

5
 CAPITAL MARKET
Capital market (Primary & Secondary) players
include:
– Issuers (for equity and debt)
– Merchant bankers
– Underwriters
– Brokers
– Stock exchanges
– Custodians & depository participants
– Rating agencies
– Mutual funds
– Registrars and transfer agents
 
Capital market is regulated by
6
Securities & Exchange Board of India (SEBI)
 CAPITAL MARKET

 
Primary – issue of fresh securities
Secondary – buying and selling of existing securities

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 MONEY MARKET
Money market is concerned with :
The demand and supply of short – term funds
 
Money market instruments: call money, treasury
bills, commercial papers, govt securities maturing
within one year
Money market players: Banks, financial institutions,
security dealers, corporates

Money market is regulated by

Reserve Bank of India (RBI)

8
 FOREIGN EXCHANGE MARKET
Forex market is concerned with
The demand and supply of foreign exchange
 
Forex
  market players: Exporters, Importers, Forex
dealers, etc.

Forex market is regulated by

Reserve Bank of India (RBI)

9
 INVESTOR CONCERNS

Common investor concerns are:

 
 Return on his investment
 Safety of his fund
 Liquidity, in case of a financial exigency
 Tax efficiency of the investment

10
 RISK-RETURN TRADE-OFF

A financial asset (like bank deposit, equity share, bond)

gives returns to its holder because:
• He abstains from the use of money, and
• He carries certain risks
 
Hence the relationship between risk and returns
• Lower the risk, lower the returns
• Higher the risk, the possibility of higher returns

Different Asset classes present different Risk-

Return opportunities
11
 FINANCIAL ASSETS

Two main Financial Asset Classes:

• Equity
• Debt

12
 EQUITY

Characteristics of Equity: 

• Proportional ownership
• Voting rights
• Limited liability
• Varying returns – dividend
• Residual claim – dividend

13
 DEBT

  Characteristics of Debt: 
• No ownership
• No voting rights
• Control through conditions
• Fixed returns – interest
• Preferential claim – interest

14
 EQUITY MARKET: STOCK EXCHANGE

A secondary market institution which helps in the

price discovery, allocation of resources and providing
liquidity to the market players, all at a very low cost

Premier Stock Exchanges:

Bombay Stock Exchange (BSE)
National Stock Exchange (NSE)

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 STOCK MARKET TERMS

Bulls:
Market players who expect the general share prices to
go up

Bears:
Those who expect the general share prices to fall

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 STOCK MARKET TERMS

Market capitalisation:
Number of equity shares outstanding x share price
A measure of market strength of a company
Example:
Market capitalisation as on April 10, 2006:
Name of company Rs. In crores
ONGC 1,84,344
Reliance Industries 1,16,344
Infosys Technologies 87,496

17
 STOCK MARKET TERMS
Market index:
Comprises a group of securities that are representative
of the broad economy
Weightage given to each scrip as per its market
capitalisation (or free float)
Can be used as a benchmark for measuring a fund’s
performance

Popular indices:
BSE Sensitivity Index (BSE Sensex) comprising 30
shares traded on the BSE
S&P CNX Nifty comprising 50 shares traded on the
NSE

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 STOCK MARKET TERMS

Earning Per Share (EPS):

Profit After Tax (PAT) divided by number of shares
A popular measure of profitability of a company’s
operations
  Example:
PAT of a company : Rs.10 cr.; Its shares number : 1 cr.
Then its EPS is 10
 

19
 STOCK MARKET TERMS

Price/Earning Ratio (P/E Multiple):

Price of a share divided by EPS
A popular measure of value assigned by the market to
a company’s share.
  Staying with the previous example:
Price of the share: Rs.150, Then its P/E is 15
 
P/E can also be calculated for an industry or market as
a whole

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 EQUITY MARKET
Equity as an asset class presents two kinds
of risks
  Systematic risk, also called market risk:
• Arises due to macro factors; like GDP growth, Rate
of Inflation, Rate of Interest, etc.
• Cannot be managed by an individual investor
Unsystematic, unique or company-specific risk:
• Arises due to factors specific to the security, like
development of a new product, labour strike, etc.
• Can be managed by creating a diversified
portfolio (favourable developments in one firm
may offset adverse happening in another)

21
 An investor is more concerned
with portfolio return than specific
security return

22
 EQUITY MARKET

Rate of Return on an Equity Share:

The rate of return has to factor both the dividend and
appreciation
Rate of return = Dividend + Ending Price – Beginning Price
Beginning Price

Example: Rs.
Price at the beginning of the year 60.00
Dividend received 2.40
Price at the end of the year 69.00
Rate of return = 2.40 + 69.00 – 60.00 = 0.19 or
19%
23 60.00
 DEBT MARKET
Uses fixed interest instrument like Bonds or
Debentures
  A Bond
• A popular Debt Market Instrument
• Akin to a Promissory note
• Issued by a business or government unit
• Carries a fixed interest rate, called Coupon rate
An actual rate of return on a bond is called bond yield.
Example: A Rs.100 FV bond carrying 10% coupon rate
and bought at Rs.120 gives a yield of 8.3%
Rule of 72 –
72 divided by the interest rate gives the period in which
the amount gets doubled. At 8%, it takes 9 years.
24
 DEBT MARKET

Embedded options in a bond:

Fixed income securities sometimes contain

Put Option: Gives right to the investor to redeem the

bond at a fixed price within a specified time

Call Option: Similar right of buy back to the issuer

25
 DEBT MARKET

Rating of Corporate Bonds:

Corporate bonds are rated on the basis of the company’s

profitability and financial position to service and redeem
them.
 
Different ratings: AAA, AA, A, BBB, BB, B, C, D,
AAA being the highest rating and D standing for default
being the lowest.
 
Four major rating agencies licensed with SEBI are:
CRISIL,ICRA, CARE and FITCH

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 DEBT MARKET
Debt Market risks:

Fixed interest securities like bond are exposed to:

• Default risk – Possibility of borrower not paying
interest or repaying debt
  
• Market risk (rate of interest risk) – Bond Yield and
Security Prices are inversely related
 

Contd.

27
 DEBT MARKET
Debt Market risks:

A fall in interest rate lowering the bond yield raises

security prices and vice versa

Government securities, though free from default risk,

are subject to interest rate risk. Corporate bonds are
exposed to both
 
Reinvestment risk (Risk associated with investment of
fund generated by redemption/ returns of existing
investments) is also associated with investment in fixed
interest securities
28 Contd.
 DEBT MARKET
Debt Market risks:

Example:
Year Face Tenure Coupon
value rate
2002 100 10 Yrs. 7%

2003 100 10 Yrs. 6%

100 X 7 / 6 = 116.7
Returns = 7 + 16.7 = 23.7%
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 RATE OF INTEREST
Money has time value.
A rupee today is more valuable than a rupee a year hence.
 
The impact of interest on our investment can be seen
through tables showing:
1.  Future value of single amount
2. Future value of annuity
3. Present value of single amount
4. Present value of an annuity
 
These tables can be beneficially used for retirement
planning
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 MAGIC OF COMPOUNDING
If you start investing at age 30 @ Rs.1000 pm upto age
60, at 13% compound interest p.a., you will accumulate
a corpus of Rs.40 lakhs.
 
Advantage of an early start
 
Same example, if you start investing at age 25 (just 5
years earlier), the accumulation will be nearly double.
 
Useful strategy for educating a client who is delaying a
decision

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 RATE OF INTEREST
Rate of interest is at the core of the debt market.
It is the rental price of money paid for the use of
money for a period of time
It decreases:
• When inflation is low
• Maturity period is short
• Default risk is negligible
It increases:
 
• When inflation is high
• Maturity period is long
• Default risk is high

  
Money market instruments carry low interest rate
because the maturity period is short and default risk
32
 SMALL SAVING SCHEMES
Scheme Interest Max. Investment Tenure Tax Benefits
(%)
National Savings 8.00 No Limit 6-years Sec. 80C
Certificates
Public Provident 8.00 70,000 15-Years Sec 80C, Sec
Fund 10
Kissan Vikas Patra 8.41 No Limit Money doubles No tax benefit
in 8-years,
7 months
Monthly Income 8.00 Single A/C: 3 Lakh 6-years No tax benefit
Scheme Joint A/C: 6 Lakh

Term Deposits 6.25 – 7.50 No Limit Available for 1, No tax benefit

2, 3, 5 years
Recurring Deposits 7.50 No Limit 5-years No tax benefit
Savings Account 3.50 Single A/C: 1 Lakh - Sec 10
Joint A/C: 2 Lakh
RBI Savings Bond 8.00 No Limit 6-years No tax benefit
33
 SMALL SAVING SCHEMES

UNIT Linked Insurance Plan with

Sec 10 (10D) and Sec 80C benefits
capable of giving better returns.

34
 INFLATION AND REAL INTEREST RATE
The nominal interest rate on a debt instrument is the
rate in nominal terms whereas the real rate is the
one corrected for inflation. Formula:
 Real rate = Nominal Rate – Inflation Rate
1 + Inflation Rate
Example: if you earn a nominal rate of 8% on your
investment, with inflation at 5%, your real rate works
out to 2.86%
With inflation hovering around 5%, fixed interest
avenues like bank deposits are giving negative or
marginal real returns. Market related returns are
the answer.

35
 TAX ON CAPITAL MARKET RETURNS

Dividend on shares
Exempted from income tax

Capital gains on sale of securities on a stock

exchange
• Short-term: taxed at 10% flat
• Long-term: Exempt

Interest on Corporate Bonds/Debentures:

Taxed as normal income

36 Contd.
 TAX ON CAPITAL MARKET RETURNS

Securities Transaction Tax (STT) on securities

transacted on a stock exchange

Equity:
• Delivery based : 0.25% ( To be equally shared by
both seller & buyer)
• Day trading : 0.025% (payable by the seller)
• Derivatives : 0.017%

Debt:
• Exempt from STT

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 MUTUAL FUNDS

38
 MUTUAL FUNDS

• An investment vehicle

• Pools the savings of a large number of investors

• Invests it in various securities

• To meet their common financial goal

• An alternative to investing directly

• Returns shared in Proportion to holdings

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 MUTUAL FUNDS

Advantages:

• Portfolio diversification - leading to reduced risk

• Professional management
• Small investments possible
• Liquidity
• Transparency
• Convenience and flexibility
• Low transaction costs

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 MUTUAL FUNDS
Structure:
Sponsor

Trust/ Asset Management

Trust company Company

Sponsor - creates the mutual fund in the form of trust

or trust company and also AMC
Trustees/ Trust company - to protect the interest of
the unit holders
Asset Management Company (AMC) - to manage
the funds for a fee.
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 MUTUAL FUNDS

Outsourced services:

Banks - to transfer funds

Custodian/ Depository participant- to keep securities

Registrars - to handle investor related services

Distributors - to sell funds to the investors

42
 MUTUAL FUNDS
Mutual Funds Operation Chart

Investors
Pool their money.
Converted into units
Passed back to
with
Returns Fund Managers

Generate Invest in

Securities

43
 MUTUAL FUNDS
Unit: The currency of a fund issued against your
investment.
What a share is to a company, a unit is to a fund.
Net Asset Value (NAV):
• The price at which a unit is bought or sold.
• The simplest measure of how the fund is performing
at any point of time.
• A fund’s NAV is its net assets (market value of
securities minus any liabilities) divided by the no. of
units it has issued

NAV = Assets - Liabilities

No. of units outstanding
44
 MUTUAL FUNDS
Types of Mutual Funds:

By Structure:
1. Open-Ended Fund
2. Close-Ended Fund

By Asset Class:
3. Equity Fund
• Diversified Equity
• Sector Funds
• Index Funds
• Exchange Traded Fund
• Equity Linked Saving Scheme (ELSS)
Contd.
45
 MUTUAL FUNDS
By Asset Class:

2. Debt Fund
• Income Fund
• Floating Rate Fund
• Gilt Fund
• Liquid Fund
• Short Term Fund
• Flexible Fund

3. Balanced Fund

Contd.
46
 MUTUAL FUNDS
By Asset Class:

4. Others
• Fund of Funds
• Dynamic Fund

5. In the Offing
• Real Estate Fund
• Gold Fund

47
 OPEN & CLOSE ENDED FUNDS

Open-Ended Fund :
• Available for sale & repurchase at all times at NAV
related price
• Accent on liquidity
• Popular because of ease of entry and exit.
Close-Ended Fund :
• Has a fixed tenure (2-15 years).
• Makes a one time sale of fixed number of units.
• Generally listed on stock exchange to provide
liquidity
• Traded at discount to NAV.
.
48
 EQUITY FUNDS
Diversified Equity Fund:
Invested in several stocks across sectors (min. 65%).
Good proxy for stock market.
Aims to outperform the market, represented by indices
like BSE Sensex and Nifty.
Sector Funds:
Invested in stocks from only one industry or sector
Considered as the riskiest amongst all equity funds
because of limited diversification.

49
 EQUITY FUNDS
Index Funds:
An equity fund with diversification limited to stocks in
an Index (Like Sensex or Nifty) with the same weightage
It mirrors such an Index.
1% tracking error is reasonable.
Passive fund management
Exchange Traded Fund
Cousins of Index fund.
Also mimics an Index.
Difference: Listed and traded on a stock exchange.

50
 EQUITY FUNDS

Equity Linked Saving Scheme (ELSS)

A diversified equity fund (100% equity)

Tax benefit under Sec 80C (deduction from income

upto Rs.1,00,000)

Minimum Lock-in period of 3 years

51
 DEBT FUNDS
Income Fund:
Invested in diversified fixed interest securities like
corporate bonds and government securities with
medium to long tenure.
Securities are rated.
Lower risk as compared to equity fund.; yet exposed to
default, rate of interest & liquidity risks.
Suitable to people looking for regular income.
Floating Rate fund:
Invested in floating rate debt instruments.
Insulated from interest rate risk.

52
 DEBT FUNDS
Gilt Fund
Invested in government securities with medium to long
term maturities.
Carry zero default risk; yet exposed to rate of interest
risk.

Liquid Fund
Invested in money market instruments (Call money,
Treasury bills, Commercial paper, G-Sec maturing
within 1 year) .
Risk free; hence give low returns.
Used for parking funds waiting for stable investment.

53
 DEBT FUNDS
Short Term Fund
Also invested in Money market instruments .
Plus the portfolio would include G-Secs maturing in
medium term
Average maturity 2 years.
Give returns higher than liquid funds.

Flexible Fund
Gives complete freedom to fund manager to choose debt
instruments in any proportion.
Aims at maximising returns from debt instruments.

54
 BALANCE FUNDS
Balance Funds:
Invested in a portfolio comprising both Equity and
Debt instruments in varying proportion.
Aimed at generating some capital appreciation and
earn some regular income.
Monthly income plans with equity component upto
30- 35% are also a kind of balanced fund.

55
 OTHER FUNDS
Fund of Funds:
Invested in other mutual fund schemes instead of
investing in Equity & Debt securities.
Achieves greater diversification.
Dynamic Fund:
Also known as ‘Asset Allocation Fund’.
Invested in Debt and Equity in any ratio.
Gives more elbow room to the fund manager for
maximising returns.

56
 GROWTH AND DIVIDEND PLANS

A unit holder has the option to choose from

1. Growth Plan
2. Dividend Plan
3. Dividend Reinvestment Plan

Contd.
57
 GROWTH AND DIVIDEND PLANS
Growth Plan:
All gains made by your scheme remain invested with
it.
The appreciation in value gets reflected in rising NAV.

Example:
Rs,. 10,000 invested at NAV of Rs. 10 (1000 units),
would accumulate to Rs. 11,000 if NAV has moved to
Rs. 11 after a certain period

Contd.
58
 GROWTH AND DIVIDEND PLANS
Dividend Plan:
A dividend plan distributes periodically the gains made
by it to unit holders.
Gains are distributed in the form of dividends declared
as a percentage of unit par value.
Post dividend, the NAV gets reduced by the payout.

Continuing with the earlier example, if it is dividend

option and a 10% dividend (Or Re. 1 per unit, i.e. Rs.
1000 ) is declared when NAV is Rs. 11, the post
dividend NAV will come down to Rs. 10
What you gain by dividend, you lose by NAV
59
 GROWTH AND DIVIDEND PLANS
Dividend Reinvestment Plan:
Dividends are reinvested in the scheme at the ex-
dividend NAV instead of being distributed.

Continuing with our example, a 10% dividend

(Or Re. 1 per unit) declared when NAV is Rs. 11, the
post dividend NAV will come down to Rs. 10 and the
dividend (Rs. 1000) will be used to buy units of the
same scheme at the new NAV (Rs. 10).
Although the number of units present in your account
increases (1100 units), the value remains the same (Rs.
11,000)
Each of the options will have its own Tax implications
60
 RETURNS ON MUTUAL FUNDS
Returns

Returns are the gain from an investment in percentage

terms.
In the context of Mutual funds, returns are measured by
changes in NAV.

Example:
Units bought at NAV Rs. 10 and sold at Rs. 12 after a
certain period, returns work out to 20% as follows;
12-10 X 100 = 20%
10
This is known as Absolute returns
61
 RETURNS ON MUTUAL FUNDS
Annualised Returns

The problem with Absolute returns is that it does not

factor in the effect of time.
Hence the need for annualising absolute returns by
dividing it by the total period (months) and
multiplying
by 12.
Example:
Units bought at NAV Rs. 20 and sold at Rs. 22 after 2
years, returns work out to 5% as follows;

22-20 X 100 X 12 = 5%
62 20 24
 RETURNS ON MUTUAL FUNDS
Total Returns (Distribution of Dividend)

Total returns take into account any distribution of

dividend also.

Example:
Units bought at NAV Rs. 20 and sold at Rs. 22 after a
year and an interim dividend of Rs. 4 per unit, returns
work out to 30% as follows;

4 + (22-20) X 100 = 30%

20

63
 RETURNS ON MUTUAL FUNDS
Total Returns (Reinvestment of Dividend)
Total returns take into account any reinvestment of
dividend also.

Example:
Units bought at NAV Rs. 10 and interim dividend of
Re.1 per unit, reinvested at ex-dividend NAV of Rs.10,
sold at Rs. 12 after a year,
returns work out to 32% as follows:
No. of additional units allocated = 0.1 unit per existing
unit,
Thus every unit is now 1.1 unit (1 + 0.1)
The value of the investor’s holding per unit =
12 * 1.1 = 13.20 . . . Returns = 13.20 - 10 * 100 = 32%
64 10
 RETURNS ON MUTUAL FUNDS
Compounded Annual Growth Rate (CAGR):

If returns are to be calculated for more than a year,

CAGR gives a better measure of returns.
Comparisons also become meaningful.
Example:
Units bought at NAV Rs. 10 and sold after 10 years at
NAV of Rs. 20, returns work out to 7.2% as follows;
A = P 1+ R N
100
20 = 10 1+ R 10

100
R= 7.1773
65
 LOADS & CHARGES
Loads

A fee levied by a scheme on an investor at the time of

buying or selling units to cover distribution
expenses, expressed as a percentage of the scheme’s
NAV.
There are 2 types of Load:
• Entry Load (Front-end load)
• Exit Load (Back-end load)

Contd.
66
 LOADS & CHARGES

Loads

Entry Load (Front-end load):

• levied at the time of buying units
• has effect of Increasing the purchase price
• to cover initial issue expenses also in case of open-
ended fund (April 06 SEBI Guideline)

Example:
Units bought at NAV Rs. 10 with an entry load of 2%
would actually mean a purchase price of Rs. 10.20

Contd.
67
 LOADS & CHARGES
Loads

Exit Load (Back-end load) is levied at the time of

selling units
It has effect of decreasing the selling price.

Example:
Units sold at NAV Rs. 20 with an exit load of 2% would
actually mean a sale price of Rs. 19.60

Entry Load & Exit Load together (spread) should not

exceed 7% as per SEBI (MF) Regulations
68
 LOADS & CHARGES
Charges: Three types of permissible charges:

• Issue expenses (in case of close-ended funds): upto

6% of the corpus mobilised during the offer period.

• Total recurring expenses including Investment

management fee: upto 2.5% and 2.25% of the Net
assets in the case of Equity & Debt funds
respectively.

• Investment management fees: upto 1.25% of the

Net assets.

69
Charges go to reduce the NAV
 SYSTEMATIC INVESTMENT PLAN
Systematic Investment Plan (SIP):
Based on principle of ‘Rupee Cost Averaging’.
Buying at bottoms and selling at peaks not always
possible
Under SIP, your investment in the scheme is staggered.
Instead of Lump-sum, you invest a pre-specified amount
at pre-specified intervals (Monthly/ quarterly, etc.)

Advantages: SIP helps you to profit from volatility by:

• Buying more units when prices are falling and
• Buying fewer units when prices are rising
thus lowering your average purchase price.

You can just ignore the market. Contd.

70
 SYSTEMATIC INVESTMENT PLAN
Systematic Investment Plan (SIP):

• Most effective over long periods of time covering

both bull and bear phases

• Benefits are more pronounced in the case of

equity funds because of their high volatility as
compared to debt funds.

Contd.
71
 SYSTEMATIC INVESTMENT PLAN
Falling Market
MONTH SENSEX NAV INVESTMENT UNITS
(Rs.) (Rs.)
Feb '01 4,247 10.00 1,000 100.0
Mar '01 3,604 8.49 1,000 117.7
Apr '01 3,519 8.69 1,000 115.1
May '01 3,632 8.96 1,000 111.6
June '01 3,457 8.52 1,000 117.4
July '01 3,329 8.21 1,000 121.8
Total 6,000 683.6
Average 3,631 8.81
Average cost per 8.78
unit Contd.
72
 SYSTEMATIC INVESTMENT PLAN
Rising Market
MONTH SENSEX NAV INVESTMENT UNITS
(Rs.) (Rs.)
Jul '03 3,793 10.00 1,000 100
Aug '03 4,245 11.19 1,000 89.4
Sep '03 4,453 11.73 1,000 85.3
Oct '03 4,907 12.92 1,000 77.4
Nov '03 5,045 13.28 1,000 75.3
Dec '03 5,838 15.36 1,000 65.1
Total 6,000 492.4
Average 4,713 12.41
Average cost per 12.18

73 unit
 TAX ON MUTUAL FUNDS
Equity Funds - Dividend option
Dividend on equity funds (both open-ended and close-
ended - min. 65% equity) exempted from tax.
Equity Funds - Growth option
Growth to be treated as capital gains and taxed
accordingly.
Short term capital gains (Units sold within 1 year) – To
be taxed at 10% flat.
Long term capital gains (Units held for more than 1
year) -
Exempt from tax.

Securities Transaction Tax (STT) on Equity funds while

74 repurchasing : 0.25%
 TAX ON MUTUAL FUNDS
Debt Funds - Dividend option
Dividend on debt funds exempted from tax in the hands
of the unit holder. However, the fund has to pay a
dividend distribution tax of :
• 13.07% for individuals/HUF
(12.5% + 2.5% Surcharge +2% education cess)
• 20.91% for others including corporates
(20% + 2.5% surcharge + 2% education cess)

Contd.
75
 TAX ON MUTUAL FUNDS
Debt Funds - Growth option
Growth to be treated as capital gains and taxed
accordingly
Short term capital gains (Units sold within 1 year) – To
be taxed at 10, 20 or 30% applicable to the unit-holder.
Long term capital gains (Units held for more than 1
year) -
To be taxed at 20% with indexation or 10% without
indexation..

Securities Transaction Tax (STT) on Debt funds : Exempt

76
 MUTUAL FUND VS OTHER FINANCIAL
PRODUCTS
Mutual funds are preferred to:
• Direct investment in Stock market due to;
• Benefits of diversification
• Professional management
• Economies of large scale
• Fixed interest instruments because
• Mutual funds provide market related
returns while the fixed interest instruments
would be restrictive in returns.
• In a rising interest rate scenario,
investments in fixed interest securities
depreciates in value

77
 UNIT LINKED PLANS VS TRADITIIONAL
INSURANCE PRODUCTS
Unit linked plans have borrowed several beneficial
features of Mutual Funds like;
• Providing market related returns
• Diversified portfolios & choice of fund options as
per one’s risk appetite
• Professional management
• Being totally transparent on charges and
disclosures
• Liquidity in case of exigencies
without tax inefficiency and inherent risks of the
mutual funds.
Hence UL plans score over traditional insurance
plans
78
 UNIT LINKED PLANS VS MUTUAL FUND

Since both UL plans and MFs provide market-

related returns, the critical areas for comparison
would be:

• Charges & Expenses

• The tenure of investments
• Tax efficiency
• Safety of investment

79
 UNIT LINKED PLANS VS MUTUAL FUND

• If the tenure of investment is short, say 3 years,

mutual funds score over unit- linked plans. However
if the tenure is longer, say 10 years, the initial
charges of Unit Linked plans get neutralised.
• On the tax front, unit linked plans are a clear winner
with benefit of Sec 10 (10D) and Sec 80C available.
Even a 5-year tenure makes UL plans a preferred
vehicle
• Tax benefits in the case of Mutual funds have been
erratic and meagre in the past.

80
 UNIT LINKED PLANS VS MUTUAL FUND

• On the parameter of safety, most UL plans, basically

being balanced funds, are generally safer than mutual
funds.

• A UL plan makes life insurance benefits available

along with benefits of market-related returns.

• A product like CLP/PLP gives super flexibility of

making the same policy work like a total investment
plan or a total family protection plan

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 UL PLANS VS UL PLANS

Unit-linked Plans can be compared by using Internal

Rate of Return (IRR), provided:
• their maturity values and charges are known
• their risk profile is similar (you cannot obviously
compare a fund having 35% equity component with
another having 100% equity component)

IRR is compounded annual rate of return on investments

held for a period of time.

It is the rate of return that would make the present value

of future cash flows equal to the present value of
82 investment.
 UL PLANS VS UL PLANS

In the context of UL plans,

computation of IRR would involve taking:
• premiums / all charges outflows on the one hand, and
• benefit inflows on the other.
IRR is the rate that makes them equal.

With standard assumed returns (6% and 10%) prescribed

by IRDA for all plans, IRR brings out the cost efficiency
of the plans being compared.

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 THANK YOU

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