Idea that Works

Structure of New Pension Scheme

noreply@blogger.com (ram) — Tue, 10 Jul 2012 14:43:00 +0000

NPS Architecture

NPS is a well structured Defined Contribution Pension system with well defined system architecture having specified roles of various entities.

Pension Fund Regulatory and Development Authority

The Pension Fund Regulatory and Development Authority (PFRDA) is entrusted the responsibility to regulate and develop the pension market in India. The roles and responsibility of PFRDA include carrying out regulatory changes, overseeing quality and provision of services of NPSCAN, CRA, PFs Trustee Banks etc.,

New Pension System (NPS) Trustee

NPS Trust has been set up for taking care of assets and funds under the NPS. Trust has been appointed by PFRDA. Trustee is responsible for taking care of Funds under NPS. The securities shall be purchased by the PF(s) on behalf of and in the name of Trustees and the Securities purchased by each PF shall be held in the Custodial Account of NPS Trust. However, Individual subscriber shall remain beneficial owner of these securities assets and funds. NPS Trust will appoint Trustee Bank, Custodian NPS Trust will hold an account with it. Trustee Bank would receive Funds from Govt. / NPSCAN and send to PFs, ASPs Trustee Bank.

Central Record Keeping Agency (CRA)

CRA would undertake Record Keeping, Administration and Customers service. National Securities Depository Ltd (NSDL) has been appointed as the CRA for the NPS. The main functions and responsibilities of CRA will include: Recordkeeping, Administration, and Customers Service function for all subscribers of the New Pension System. Issue of unique Permanent Retirement Account Number (PRAN) to each subscriber, maintaining a data base of all subscribers, and recording transaction relating to each subscriber.

Pension Fund Managers

In order to introduce competition and to provide wider choice to the subscribers, PFRDA has allowed multiple fund mangers. The subscriber will have a choice to select from multiple pension fund managers and multiple schemes. Pension Fund Managers will manage investment of Retirement Savings of NPS. There will be no implicit or explicit assurance of benefits except market based guarantee mechanism to be purchased by the subscriber. PFRDA has appointed three pension fund managers, namely LIC Pension Fund Ltd., SBI Pension Fund Ltd. and UTI Retirement Solutions Ltd. for managing funds of Central Govt. employees (who will also manage State Govt Funds. Further, PFRDA has appointed six fund managers to manage funds of all citizens (excluding Central and State Govt Fund), which was opened to st the public from 1 May 2009.

Point of Presence (POPs)

PFRDA has appointed 22 POPs who will act as Collection Centre for NPS, will collect application forms from the subscribers (under All Citizens category) and send the same to the CRA.

Trustee Bank

The Trustee Bank will maintain the account of the Trustee and will receive credits from the government department or its agencies and transmit the information to the CRA for reconciliation. The Trustee bank shall remit the funds to the Pension Fund Managers, Annuity Service Providers (ASP). NPS Trust has appointed Bank of India as the Trustee Bank

Custodian

The Custodian will provide Custodial Services to the Pension Funds, which will include among others to ensure that benefits due on the holdings are received, provide detailed reports to the PFs etc. NPS Trust has appointed Stock Holding Corporation of India Ltd as the custodian for the new pension system.

Annuity Service Providers (ASP)

The role of annuity service providers (ASPs) will be critical in the NPS, since they will offer annuity to the subscribers when members reach superannuation or withdraw pension assets. As per the provision there would be mandatory annuitization, and the members have to purchase annuity from ASPs. The ASPs will offer annuity products to the subscribers receive funds from CRA and pay regular monthly annuity.

Employer Contribution in NPS to be exempted over and above Rs. 1 lakh

noreply@blogger.com (ram) — Tue, 10 Jul 2012 14:27:00 +0000

To make the New Pension System more attractive Government has announced two major Income tax concessions for contributions made in New Pension Scheme in the budget 2011.

While the NPS subscribers are directly benefited from one of these Income tax concessions, the second one is beneficial to the employers who contribute for NPS each month equivalent to employees contribution in Tier I.

Income tax concession to Employees under NPS:

So far, the contribution made by a New Pension Scheme subscriber in Tier I scheme is deductible from the total income under Section 80CCD of the Income Tax Act. Like wise, the contribution made by the employer for the employee in Tier I of New pension scheme is also deductible under Section 80CCD. However, the aggregate deduction under Section 80C, 80CCC and 80CCD is fixed at Rs.1 lakh.

So, if the NPS subscriber is already having other eligible deductions such as LIC premium, PPF, bank or NSC deposits, ELSS etc., under Section 80C, 80CCC and Section 80CCD., deduction allowed under Section 80CCD in respect of contribution towards New Pension Scheme may not be of much useful as the overall limit of savings eligible for deduction is pegged at Rs. 1 lakh.

Further, contribution made by the employer in Tier I New pension scheme should also be included in the Total income of NPS subscriber as far as calculation of income tax is concerned, while full deduction of the
same from income under Section 80CCD may not be possible as other savings made by the subscriber covers the overall limit of Rs.1 lakh under Section 80CCD. Hence, for a NPS subscriber contribution for NPS by the Government is taxable in most of the cases.

For example, if an employee receives a salary of Rs.40,000 (pay+da), 10% of the same (Rs.4000) is paid by him as contribution towards NPS. The Government will also be paying Rs.4000 in this case in NPS fund of the said employee. Until now, an amount of Rs.96,000 (Rs.48,000+Rs.48000) could be deductible from the total income as far as this employee is concerned under Section 80CCD.

However, if the said employee has been paying LIC premium of Rs.20,000 per year, he will be allowed to deduct only Rs.2000 in respect of the same under Section 80CC as total ceiling of Rs.1,00,000 under Section 80CCE will apply in this case. So, an eligible deduction of Rs.18,000 could not be availed under Section 80CCD. In other words, employer contribution to NPS to an extent of Rs.18,000, which is already included in the income is taxable in this case.

However, budget 2011 has proposed to amend section 80CCE so as to provide that the contribution made by the Central Government or any other employer to a pension scheme under section 80CCD shall be excluded from the limit of one lakh rupees provided under section 80CCE. It is exepected that this proposal which will be effective from the assessment year 2012-13 (financial year 2011-12) would totally exempt employer's contribution in NPS from levying income tax.

Income tax concession to Employers under NPS:

Currently, the contribution made by an employer towards a recognised provident fund, an approved superannuation fund or an approved gratuity fund is allowable as a deduction from business income under section 36, subject to certain limits. However, the contribution made by an employer to the NPS is not allowed as a deduction.

In the Budget for the financial year 2011-12, it is proposed to amend section 36 so as to provide that any sum paid by the assessee as an employer by way of contribution towards a pension scheme including New Pension Scheme (NPS) to the extent it does not exceed ten per cent of the salary of the employee, shall be allowed as deduction in computing the income under the head “Profits and gains of business or profession”.

This amendment will be effective from 1st April, 2012 and will be applicable to the assessment year 2012-13 (for the income earned in the financial year 2011-12) and subsequent years.

Meet the Trimurti

noreply@blogger.com (ram) — Thu, 05 Jul 2012 15:21:00 +0000

A long time ago when I was a kid...

On one sunny day that I still have fond memories of, my father came home in the evening with a toy pig. I turned it around and discovered that it had a hole in its back. My dad announced that it was my 'Piggy Bank'.

He fished out a 10 paise coin from his pocket and instructed me to put it through the hole in the pig's back. I did it eagerly, expecting the pig to start walking. Walk it didn't but my father patted me on my back and said,

"Son, this is your first saving. I will give you 10 paise everyday and when we have collected Rs50 we will go to the bank and get you a savings account."

Savings! suddenly a new activity had begun in my life that I understood nothing about.

My Dad noticed the puzzled look on my face. He scratched his head and suddenly a meaningful look came in his eyes. I think he remembered the ant menace that my mom had been complaining of for the past few days. He showed me the ants that were carrying grains in a line to their hiding place.

"The ants are carrying grains and saving it for a rainy day, he said.

He took out my World Book Encyclopedia and showed me various other animals that save food for a time when they may need it.

"You know that I go to office to earn money for all of us. But when I turn 58 years, I will have to retire and stop going to office. We will need money to buy food and clothing even after I retire from my job and stop earning. I need to save now, so that I can pay for our food and clothing later," he explained.

"Similarly, you can save the money I give you now to buy a good book or a paint box later," he impressed upon me.

That was my first lesson in 'saving'.

A few years later I learnt in my class that all of us have two choices. We can consume now or can consume later. Hence, savings is just postponing consumption.

Does it then mean that only what we consciously keep aside for a rainy days is called "saving"?

"No, what ever you do not manage to consume and stays as a surplus is also 'saving'. But that is a lucky state to be in," my teacher responded.

And that set me thinking...

"If I can 'save' to consume at a later date, I can also spend more now if I know that I can earn enough surplus to pay for it later..."

Just then my teacher's booming voice interrupted my train of thoughts...

"Borrowing is the opposite of saving," she announced.

Now that was easy to visualize.

I had a classmate who was fairly irregular to class, spent a lot of time in the school canteen and supposedly even bunked classes to watch the 'matinee'.

How did he manage to pay for all his nefarious activities?

Well, he used to borrow money from a few friends of mine who saved their pocket money.

During the break, I manage to accost one of those friends who had lent money to my classmate.

"I can understand why Ramesh (by the way, that was my classmate's name) borrows from you. But why do you lend him money? Can he pay back?"

"Look, I don't really intend to spend all my pocket money. I am saving up for a new cycle. Money always burns a hole in my pocket. Hence, I lend it to him," he answered.

"Ramesh has a rich father, who is a family friend," he explained. "I know that I can get my money back. Ramesh also knows that when he turns 18 he will look after his family business and earn well. And then he will have no time to have the fun he is having now. Hence, he borrows to spend," he added.

Learning for me again

'Saving' is not consuming everything today and leaving something for tomorrow whereas 'Borrowing' is consuming more than what one has today, expecting to save more later to pay up for the excess consumption now.

While 'saving' is being conservative and wise, 'borrowing' is being risky and foolish unless for a basic need. Hence, it makes sense to borrow only when one is sure that in the future he will be able to save enough not only to pay up for his borrowings but also to see him through the days when he cannot earn.

What is 'investing' then?

This question bothered me till I had my first mug of beer from some bottles that we had smuggled in from my friend's place (it belonged to his father who owned a liquor shop).

Oh boy! I loved it so much, the beer I mean. But soon an idea suggested itself to me. If everybody starts liking it, the demand for beer is definitely going to rise. The growing population will ensure that the demand sustains. Wouldn't then it make a lot of sense to set up a company to manufacture beer? If demand drops then my friends and I can very well step in!

I had grown up finally from the days of aspring to be a bus conductor to wanting to own a beer factory now!

The next day, I started discussing my ambition with my friend's father. During the course of our conversation I learnt of the money needed to buy the fermenting equipment that can produce beer for years to come.

By selling all the beer that can be manufactured, I can recover the initial money spent on the business by the end of three years. Beyond that, the money that I'll make will be surplus. That would be an awful lot of money.

Of course, I remembered that as 'Investment' from my economics textbook.

In other words, 'Investing' means building up to meet future consumption demand with the intention of making surpluses or profits, as they are popularly known.

Investments are risky

True, what if tomorrow everybody decides that 'beer' is yuck. Maybe the government will ban beer consumption. Or your plant might develop a big problem for all you know. Hence, there has to be a reasonable profit expectation to motivate an investment.

Also, when you or I 'invest', we forego our present consumption or do it out of our surplus. In other words, 'savings' again supports 'investment'.

Interesting isn't it?

We started with three things that looked as different as chalk, brick and wood, but discovered that the three ('saving', 'borrowing' and 'investing') are related.

But then, I have a few questions in my mind already. I am sure you would have some too.

What if I save Rs1000 over 10 months to buy a cycle and the price of the cycle shoots up by 20% by then? I am losing the 'purchasing power' of my Rs1000. Is there some way I can make up for the risk of losing my purchasing power?

Getting a little complicated for now. Let us unravel it later.

Should we invest in Highest NAV ULIPs?

noreply@blogger.com (ram) — Thu, 05 Jul 2012 15:08:00 +0000

Risk involved in ULIP:

Highest Nav ULIPs

ULIP (unit linked insurance plans) is a life insurance policy mixed up with an investment in the stock market. A portion of the premium paid by you is utilised towards taking a pure endowment life insurance policy and the remaining amount is invested in the stock market by buying shares of companies chosen by the fund manager.

Needless to say the portion of amount invested in the stock market would be exposed to stock market fluctuation. Just see the price of a stock in December-2007 when the market was peaking at 20K to 21K. When the market crashed afterwords shares of almost all the companies in the market fell around 60% to 100%. Again the see the recovery phase from March-2009. Most of the stocks gained a decent recovery. Some stocks were even surpassed their earliet highest price. So, the price of the units, as measured in net asset value (NAV), which is an average value of stock held in a particular scheme of the Insurance company can fluctuate a lot.

Take the case of a person buying a ULIP. He always has the risk that his capital invested in the units can be eroded, if the markets is weak. Thus at maturity of the policy, one might not get a high return that one expected at the time of buying the ULIP.

Capitalising the risk involved:

Risk involved in the investment in the ULIP is actually a drawback. But insurance companies are now trying captialise this drawback itself for mobilising new funds in the form of providing the scheme known as “Guaranteed NAV ULIPs”

Highest NAV ULIP- The real name is Constant Proportion Portfolio Insurance:

The investment process followed in these “highest NAV guaranteed” Ulips is called Constant Proportion Portfolio Insurance — a trading strategy designed to ensure that a fixed minimum return is achieved at a set date in the future. This strategy involves a continuous re-balancing of the portfolio of investment between equity and debt.

Consider a Ulip promise to pay highest NAV in the next seven years that starts today at a NAV of Rs 10. Let us assume that 100 per cent of the allocated premium is invested in equities.

Now, the market goes up and at the end of the first year the NAV increases to Rs 15. This is the highest NAV of the Ulip till now and the insurer has to make sure that the policyholder can be repaid at the end of the remaining six years on the basis of the Rs 15 NAV.

Shuffling is the key:

The company would now transfer a part of investment made in the equity market to debt instruments such as govenment or private bonds that ensure a return of Rs 15 after six years.

In the second year, the markets do down and the NAV declines to Rs 11 from Rs 15. However, the insurer doesn’t need to do anything as the return of highest NAV has been ensured by the investment bebt market.

Now comes the prudency of the fund manager of the scheme. Since is market is low as we assumed that NAV has declined from Rs.15 to Rs.11, the fund manager has the liverage now to re-invest part of the amount withdrawn from the equity debt when the NAV was Rs.15, in the equity market again at a lower price. This action may lead to appreciation of NAV further. But this element of risk is not to be taken in the case of Highest NAV schemes as there no such declaration by the company to the extent that the appreciation gained which is available in the debt fund will be re-invested in the equity market. Obviously, the NAV of this scheme would tend to appreciate at a slow phase compared to non-guaranteed ULIPs or pure mutual fund schemes.

As per the fine print of these “Highest NAV” schemes, in the subsequent years also , if the stock market goes again a portion of the investment available in the equity fund will be transferred to debt instruments.

This sort of shift of funds from equities to debt instruments would be continued and when the policy matures, all the investment made by the policy holder would go to debt instruments.

Highest NAV guaranteed Ulips thus turn out to be primarily debt-oriented rather than equity-oriented plans — you can expect a gross return of between 8 per cent and 10 per cent on investment. But since there are various charges associated with a Ulip, your net return could be still lower at 5 to 7 per cent. Besides, guarantees come at a cost. The total cost of these guaranteed Ulips are higher than that in a non-guaranteed product.

This guaranteed NAV scheme is not offered by Mutual funds as they are not allowed by the market regulator Sebi to provide any kind of guarantee to investors either on capital or on investment returns.

But insurance regulator IRDA allows life insurance companies to offer guarantees on their products, even when these are market-linked.

Even the life cover and the tenure of such highest NAV guaranteed Ulips are not as beneficial to customers as in non-guaranteed insurance plans. The sum assured offered is generally five times the annual premium and the policy term is 10 years. So, these plans are not only giving you a smaller life insurance, they are covering a shorter span of your life.

Who should Invest in These Products ?

If you are looking for modest returns, like 8-10%, you can invest in these policies. The return of these policies may be high in the beginning, if market does well; but when market starts performing badly, the returns can take a hit and then be in a tight range. Your NAV will be protected for sure.

The bottom line is if you are more concerned about the worst side of market investment, which may lead to capital erosion some times, Highest NAV/Guaranteed NAV Scheme may suit you. But you got be contend with low or medium capital appreciation.

Know your credit card

noreply@blogger.com (ram) — Sun, 17 Jun 2012 14:29:00 +0000

Credit Card is no more a white elephant in India. Just like having an account with a bank credit card has become a common financial instrument among middle class. But, do we know the mechanism of Credit Card finance as we do about banking ? Obviously the answer will be “No”. A wise usage of credit card would surely benefit us. The advantage is you get a financial leverage without incurring any additional cost towards the same if you are able to settle the amount within the stipulated time.
According to the Bureau of Labor Statistics, for instance, last year Americans paid a record $16.3 billion in credit card late fees alone — little surprise , especially in view of the fact that the average American household is now juggling 14 credit cards. This is not to suggest that we Indians are better placed. One Mumbai family, which recently committed suicide, reportedly had 73 credit cards! RBI data suggests that there are now over 88 million cards in circulation in India compared to just 60 million in 2006-07, with the total outstanding balances till May this year having gone up by a whopping 87% to Rs 12,375 crore.
A small awareness about the card could save you lot of money.
What’s in a Credit Card?
1. Name. The full name of the account holder — the person who is responsible for paying the credit bill each month.
2. Issuer. The name of the company that is granting the credit and their logo. Issuers are usually banks and other financial institutions.
3. Type of Card. VISA, MasterCard, etc.
4. Account Number.
* First Six – Identify the issuer.
* Next four – Region/branch of issuer.
* Next five – Your account number.
* Final number – Digit for security.
5. Customer Service Number. This number is available if you should have any questions about your account or past transactions. There is also a number for lost or stolen cards. Write it down.
6. Magnetic Strip. This strip stores important information about your account such as name, account number, PIN, expiration date, and credit limit.
7. Expiration Date. Merchants require this information if you’re making a purchase by phone or the internet. It lists the date your card will expire in Month/Year. Most cards are valid for 1-3 years before they expire.
How does a Credit Card Work?
1. Purchase. When you purchase something with a credit card (MasterCard in this example), the merchant first checks to see if the amount you’ve charged will be approved — to make sure you haven’t exceeded your credit limit. They do this by sliding your card through an electronic device that is connected to an approval network. Once accepted, you’re given a printed receipt to sign. Both you and the merchant each keep a copy of the receipt.
2. Merchant and bank. The merchant deposits the credit card receipt with their bank, which credits their account in the amount charged. The bank then sends this transaction electronically to MasterCard.
3. MasterCard. MasterCard continues the transaction by crediting the bank and then charging the issuer of the card.
4. Card Issuer. The issuer of the card completes the transaction cycle by sending a bill to the card holder for the purchase amount. Hopefully, the card holder pays the bill in full thus avoiding any interest or finance charges.

credit card flow chart

Step 1: The merchant submits a credit card transaction to the Authorize.Net Payment Gateway on behalf of a customer via secure connection from a Web site, at retail, from a MOTO center or a wireless device.
Step 2: Authorize.Net receives the secure transaction information and passes it via a secure connection to the Merchant Bank’s Processor.
Step 3: The Merchant Bank’s Processor submits the transaction to the Credit Card Interchange (a network of financial entities that communicate to manage the processing, clearing, and settlement of credit card transactions).
Step 4: The Credit Card Interchange routes the transaction to the customer’s Credit Card Issuer.
Step 5: The Credit Card Issuer approves or declines the transaction based on the customer’s available funds and passes the transaction results, and if approved, the appropriate funds, back through the Credit Card Interchange.
Step 6: The Credit Card Interchange relays the transaction results to the Merchant Bank’s Processor.
Step 7: The Merchant Bank’s Processor relays the transaction results to Authorize.Net.
Step 8: Authorize.Net stores the transaction results and sends them to the customer and/or the merchant. This communication process averages three seconds or less!
Step 9: The Credit Card Interchange passes the appropriate funds for the transaction to the Merchant’s Bank, which then deposits funds into the merchant’s bank account. The funds are typically deposited into your primary bank account within two to four business days.
How are finance charges calculated?
If you expect to pay your balance over a extended period of time, you should understand how your creditor computes finance charges. New purchases accrue interest immediately and finance charges are actually added to your balance each month — you’re essentially paying interest on interest. This alone is a good reason to pay your balance in full each month. Let’s take a look at a few balance computation methods:
Average Daily Balance. This is the most common method used by creditors. You are charged interest on the average amount you owed each day during the billing period (minus any credits made on a particular day during the cycle). Depending on your credit agreement, new purchases may or may not be added to the balance — cash advances are usually included.
Previous Balance. The creditor uses the outstanding balance from the previous billing cycle. Payments, credits, or new purchases are not included. This is the most expensive method.
Adjusted Balance. This method is similar to “previous balance” except that payments or credits received during the current billing cycle are subtracted from the previous outstanding balance. New purchases during the current cycle are not included. Adjusted Balance costs you the least.

Internet Banking-Safety is in your hand

noreply@blogger.com (ram) — Wed, 06 Jun 2012 15:27:00 +0000

Use of Internet and ATM for banking is common nowadays. Even a novice could operate internet banking interface with ease.

Yet use of ATMs and Internet banking for banking could be termed as a double-edged weapon.

If it is not handled properly you could end up in loosing your hard earned money.

We provide here various methods used by fraudsters to hoodwink the users of internet banking and ATMs. We have also listed the safeguards suggested by bankers for safe use of internet banking and ATMs

Phishing

Phishing flow chart

Phishing is an attempt by fraudsters to ‘fish’ for your Banking details. A phishing attempt usually is in the form of an e-mail that appears to be from your Bank.

The e-mail usually encourages you to click a link in it that takes you to a fraudulent log-on page designed to capture your details.

Fraudsters send fake e-mails claiming that your information has been compromised, due to which your Bank account has been de-activated/suspended.

They will ask you to hence confirm the authenticity of your information/transactions like credit card number, personal identification number (PIN), passwords etc.

In-Session Phishing

Typical fraudulent pop-up window

This fraudulent method is more sophisticated. Even regular internet users could fall as prey.

In-session phishing is a method used by fraudsters where malware detects when the account holder enters into bank internet banking account by entering username and password.

After your open your bank website a pop-up window would open above your bank web page and would ask you type username and password. This pop up window is not belonging to bank but to the fraudster who would steal your banking information.

Since the user has logged on to the Banking website only a short while before, he is not likely to suspect the authenticity of this pop-up and is thus more likely to provide the requested details.

Spoofing

Spoofing Model for showing fake bank website

This is more sophisticated form of phishing. Website spoofing is the act of creating a website, as a hoax, with the intention of performing fraud.

To make spoof sites seem legitimate, spoofers use the names, logos, graphics and even code of the actual website.

They can even fake the URL (website address) that appears in the address field at the top of your browser window and the Padlock icon that appears at the bottom right corner.

In this case just like phishing Fraudsters send e-mails with a link to a spoofed website asking you to update or confirm account related information.

This is done with the intention of obtaining sensitive account related information like your Internet Banking user ID, password etc.

Fake Bank Login Page

Check for the Padlock icon: There is a de facto standard among web browsers to display a Padlock icon somewhere in the window of the browser For example, Microsoft Internet Explorer displays the lock icon at the bottom right of the browser window. Click (or double-click) on it in your web browser to see details of the site’s security.

Actual Bank Login Page

It is important for you to check to whom this certificate has been issued, because some fraudulent websites may have a padlock icon to imitate the Padlock icon of the browser. Check the webpage URL. When browsing the web, the URLs (web page addresses) begin with the letters “http”. However, over a secure connection, the address displayed should begin with “https” – note the “s” at the end.

For example: if a bank’s login page url is http instead of https there is every possibility that the login page you have entered is not genuine. Note here only login page will have this secured connection while the home page or other pages of your bank website addresses (URL) will start as http only.

Vishing

Vishing Model

Vishing is a combination of Voice and Phishing that uses Voice over Internet Protocol (VoIP) technology

In this method fraudsters would be feigning to represent Banks. Usually a recorded voice would seek for your bank details.

It is an attempt to trick unsuspecting customers into providing their personal and financial details over the phone.

If the bank or credit details are entered though telephone system those details will converted into data by the machine and sent to fraudsters.

Skimming

Typical tampered ATM

Skimming is a method used by fraudsters to capture your personal or account information from your credit or ATM card.

Your card is swiped through the skimmer and the information contained in the magnetic strip on the card is then read into and stored on the skimmer or an attached computer.

Fraudsters insert a skimming device to the ATM’s card slot. This device scans the card and stores its associated information.

While a customer keys in his PIN, the wireless skimming device transfers the data to the fraudsters.

This information is then used by the fraudsters for online shopping or to make counterfeit credit cards.

At restaurants and shopping outlets, the credit card is swiped twice, once for the regular transaction and the other in the skimmer that captures the personal information which is retrieved later by the fraudsters.

Money Mule

Once the fraudster has captured personal information using anyone of the ways mentioned above, they need an account to which they can transfer funds from the compromised account. This is where a “Money Mule” comes into picture. A Money Mule is an unwitting participant in the frauds who is recruited by fraudsters to launder stolen money across the globe. Fraudsters contact prospective victims (money mules) with job vacancy ads via spam e-mail, Internet chat rooms or job search Web sites. Jobs usually are advertised as financial management work, and ads suggest that no special knowledge is required. Once recruited, money mules receive funds into their accounts. Mules then are asked to take these funds out of their accounts and forward them overseas.

Tips for safe internet and ATM Banking:

Bank will never send e-mails that ask for confidential information. If you receive an e-mail requesting your Internet Banking details, you should not respond.
Always type in the URL yourself in the browser (say internet explorer) whenever you access bank site for internet banking. Don’t use bookmarks, links, shortcuts etc.
Never click on any links or attachments present in an e-mail that seems suspicious.
Do not open multiple browser windows when you Bank online to avoid In-session phishing.
Never type in your account details, user ID, password, etc. in any pop-up that may appear when you Bank online.
Always log off and close the Internet browser window after you have finished your online Banking session.
Never provide your bank details or credit card number over phone though the person talking on the other side is staff of bank or credit card company. Also do not call and leave any personal or account details on any telephone system that you are directed to by a telephone message or from a telephone number provided in a phone message, an e-mail or an SMS especially if it is regarding possible security issues with your credit card or Bank account.
Sign on the reverse of your credit card as soon as you receive it.
change ATM pin frequently to avoid skimming
Keep a cap on the amount that you deposit in the bank, the ATM card of which you use to withdraw money often. In other words, do not deposit your entire savings in the bank which you transact often though ATM card. Instead you can deposit only the amount that is required for your monthly expenses in the account for which you use ATM card often. Your savings could be made in the account for which you never use ATM card.
Collect your receipts at ATM’s, restaurants and shopping outlets.
Use your card with merchants that you know and can trust. Never allow a shopkeeper to take your card to a different shop/room for swiping.
The law states that cardholders are not liable for fraudulent transactions as long as the original card is still in their possession. The problems arise when a card is stolen or lost and is then used fraudulently.

Above all, always use reputed anti-virus and anti-spyware tools to keep your computer virus/malware/trojan free. Because these unwanted installations may prompt you to provide your personal and bank details, which will then be sent over internet to the fraudsters.

Do Govt Employees need Health Insurance ?

noreply@blogger.com (ram) — Tue, 15 May 2012 15:31:00 +0000

“Why should I go for a Health Insurance if I am a Government Employee? I am already covered by either CGHS or Medical Attendance Rules.” This may be your thought process when you start reading this article.
But the reality is in case of an unfortunate event like you or your family members had to be admitted in a good hospital for a medical treatment, the present health schemes such as CGHS or Medical Attendance Rules might not cover the entire medical expenditure as these schemes have a cap in the form of package or schedule rates. And the net result is you will not be reimbursed with what you had actually paid to Hospital. Will health Insurance schemes could come in handy at these kind of situations ?
Answer for this question may not be affirmative if you had asked this question last year. Because till last year Government norms for claiming medical reimbursement and Health Insurance claim simultaneously was bit stringent as the total of reimbursement from the government and the health insurance claim shall not exceed the package rate prescribed by the Government. In other words there was no additional benefit in taking a health insurance policy if you are a government employee.
However, this year this condition has been relaxed. We can claim medical reimbursement from Government as well the hospitalization expenses from the Insurance Company, provided the total claim should not exceed the actual expenditure.
Click here to go through this earlier article on GConnect about Govt orders on claiming medical reimbursement as well as insurance claim
Be an early bird:
Also most people tend to think that Health Insurance is something that they need to think about only when they grow old.
However, the fact is Health insurance premium tends to increase with age – more the age, higher the premium. So insure at a young age. So that your insurance gets fixed at a low cost and by the time you grow old and the money become dearer, your insurance premium cost will be almost negligible.
Stay insured:
The other truth is that health insurance protects you in case you become seriously ill or meet with an accident. A sudden accident, loss of health or natural disaster can happen to anyone. Such situations can drastically alter a person’s life, causing loss of income and inability to pay bills. So, it makes sense to stay insured
Cost of Health Insurance:
A health insurance policy not only covers the cost of financial losses when disaster strikes, but also helps you tide over emergency medical bills due to hospitalization. If you think your health insurance premium is expensive, just wait till you receive a medical bill.
Even if someone is down with jaundice or malaria and requires hospitalization for a couple of days, his hospital bill could range from anywhere between Rs 15,000 and 25,000 depending on the hospital. And in these days of rising health care costs, imagine a chronic diabetic who needs insulin injections everyday, some one who needs frequent dialysis/chemotherapy or someone who needs continuous medication to keep living.
While taking a survey of the Health Insurance premium cost, we just found that at a cost ranging from Rs. 100 to Rs 200 per member per month, a family consists of 4 members viz., husband in the age of 40, wife in the age of 36 and two kids in the age of 12 and 7, could be covered with the health insurance benefits of Rs.2 lakhs per year. The following is the chart containing premium cost per year for a sum assured amount of Rs.2 lakhs for the family consists of 4 members as narrated above.

Please note that this is not a campaign to the insurance companies mentioned in the chart. There may be other insurance companies which could offer good rates than the premium cost mentioned in this chart. This is just an indication to emphasize that insurance premium costs are affordable. Readers are advised to verify the health insurance schemes offered by various companies before choosing the right one that suits them.

What are the other benefits of taking a Health Insurance policy?
The immediate benefit of taking up a Health Insurance policy is the Tax benefit that you can enjoy under section 80 D of the Income Tax Act.
Do not worry if you do not have adequate money to pay for sudden hospitalization or surgery. Your health insurance policy offers a cashless hospitalization facility. This facility is a great help since one doesn’t have to run around in the middle of the night to collect cash for paying up large deposits prior to admission.
If a person gets hospitalized all his medical expenses 30 days prior to hospitalization and 60 days post hospitalization will be covered. This includes nursing expenses, diagnostic and medical expenses, surgery, anesthesia cost, doctor’s expense, specialist fees, scanning, x-ray, ambulance expense, oxygen, operation theatre expenses, and cost of surgical appliances, room expenditure, day care expense and similar expenses.
There are few treatments which due to technological advancement are done as an outpatient, that is, you need not have prolonged hospitalization. These treatments are also covered under health insurance.
Reduced Health Insurance Cost over the period if no claim now:
If you are a non-claimant don’t think that your money is wasted. In fact, a Health Insurance policy is most advantageous to you when you do not claim for the first few years and stay insured continuously. You will not only enjoy the Income tax benefits under Section 80D of the IT Act, but also your sum insured gets increased without paying any extra premium by way of cumulative bonus. Or you can keep the sum assured constant and start paying lesser premium.

How can a NPS subscriber change the Scheme Preference?

noreply@blogger.com (ram) — Tue, 08 May 2012 14:38:00 +0000

Contribution of Government Employees in NPS is allocated to three PFMs, viz. SBI Pension Funds Private Limited, UTI Retirement Solutions Limited and LIC Pension Fund Limited in a predefined proportion and each of the PFMs will invest the funds in the proportion of 85% in fixed income instruments and 15% in equity and equity related instruments.

How to Change the Scheme Preference?

Scheme Preference change option is not available to Govt. subscribers for Tier I

For Tier II, the subscriber has to submit the physical application form (Form-UOS-S3) to change Scheme Preference. However, such changes can be done only once in a financial year.

You can submit the request to your POP-SP (PAO for central Government employees) through whom your Tier II account is activated. Please collect a 17 digit acknowledgement number against your request. The transaction is chargeable.

How will I know my request for change in the scheme preference is taken?

Subscriber can either check using the Pin provided in the website of Central Record Keeping Agency for NPS or can call at CRA's toll free number 1800 222 080 for the status of pending request. Please mention the 17 digit acknowledgment number received.

CRA system will send an e-mail to the Subscriber once the request is processed.

How many times a subscriber has an option to change his / her scheme preference?

At present, this facility is not available for Tier I account of Central/state Govt. employee. In future, subscriber will have the option of selection of PFM and Investment schemes (as and when PFRDA approves it). For Tier II account, you can request for a change of scheme preference once in a financial year.

Bank FD – safety at the cost of poor capital appreciation

noreply@blogger.com (ram) — Fri, 06 Apr 2012 15:34:00 +0000

Traditionally the most favoured investment avenue in India, bank deposits continue to hold fort even today. The total fixed deposits with banks in India amount to a whooping Rs 35,68,435 crore (Rs 35,684.35 billion) as per Reserve Bank of India data. Bank deposits do not have the excitement surrounding other investment avenues like equity shares or real estate investments. But bank deposits serve the purpose of preserving capital, which is the most wanted at certain times.
Current income
Bank deposits are most sought after for this purpose. They give a stable and fixed return on the invested money. Traditionally, the interest rate is fixed during the tenure of the fixed deposit. Some banks now-a-days have gone for the reduction in existing bank deposits too, when the market interest rates come down.
The income comes to us in the form of “interest” for the deposit amount. The principal (initial amount invested) is returned back to us at the time of maturity. There are options to receive the interest on a monthly/ quarterly / half-yearly or yearly basis. In case we do not need the interest to come to us during the term of the deposit, we can opt for the cumulative deposit option, where it is credited to the deposit and earns additional interest. Interest is generally compounded on a quarterly basis.
The historical average return from fixed deposits in India is approximately 8 per cent for long term deposits (5 years). The highs and lows have been in the range of 13 per cent to 4 per cent.
Capital appreciation
Capital appreciation does not apply to bank fixed deposits. Only the principal invested is returned back at the time of maturity.
Risk
Perhaps the main reason for investment in bank deposits is safety of the principal. The capital (only upto Rs100,000 though) has the highest safety compared to any other investment as it is guaranteed by the Deposit Insurance & Credit Guarantee Scheme of India. All banks operating in India are covered under this scheme.
More than this guarantee, the close monitoring that RBI has on all banks in India is a big advantage to the safety of the investors in fixed deposits.
The risk faced when investing in bank deposits is the interest rate risk. This is associated with the lost opportunity to invest in an instrument that has a higher return. Getting out of a fixed deposit can be costly (up to 1 per cent of the principal), when we exit prematurely. So we may have to forgo potential earnings when the interest rate has risen only by about 1 per cent.
The highest risk faced with fixed deposits is the effect of inflation. The real return after adjusting for inflation is very less or sometimes negative for fixed deposits of banks. This is a big burden, particularly for retired people, who have invested their retirement proceeds to get regular income. Their income may be regular and steady but the money’s worth keeps going down during the tenure of the fixed deposit.
Liquidity
Bank deposits have good liquidity. They can be closed and the principal withdrawn within a few hours in some banks to a couple of days in others.
The other option is to take a loan on the fixed deposit. Banks lend upto 90% of the principal of the deposit. Interest charged for this is only about 1 to 2 per cent and only for the period that we have used the cash (The feature works like an over-draft against the fixed deposit).
Tax treatment
Bank fixed deposits are not tax efficient. The interest is taxed. Also there is no benefit from making the investment.
There are the 5-year bank deposits (tax saving) that give benefit under section 80C of the IT Act. But the benefits such as partial withdrawal or closure, and loan facility are not available. The deposit rates are also lower compared to the normal fixed deposits. This effectively negates the tax saved.
Convenience
This is pretty high with bank deposits. The investments can start from very low amounts (Rs 100 in most cases). There are no upper limits for investment. However, investments above Rs 50,000 will require your PAN card.
For a regular saving for a short period (up to 2 or 3 years maximum) the recurring deposit option can be made use of. Most banks offer standalone deposit accounts, though some may ask for starting a linked savings account.
The deposit periods can even be for very short periods starting from 15 days. This helps us to temporarily park funds before we could decide on an investment or an expense (choosing the wedding ring or buying a car for example.)
Fixed deposits can also be linked to savings accounts of banks in the form of a sweep-in-deposit. This gives the benefit of higher rate of return (when money is in excess) and flexibility to use the money when required.
In conclusion
The bank deposit primarily serves us to preserve capital. Banks now-a-days have added a lot of additional benefits to the traditionally benign service. Retired people could make the best use of this avenue for securing a fixed and steady income.
The caution is not to use the fixed deposit as a long term investment avenue. The reason is that the real return is very less when adjusted for inflation. The tax treatment of the interest also eats into the returns.
Source : rediff.business.com

How NPS repays?

noreply@blogger.com (ram) — Thu, 29 Mar 2012 14:46:00 +0000

The Government of India has introduced New Pension System (NPS) in January 2004 which is mandatory for employees joining services w.e.f. January 2004.

NPS has been extended to all citizens as a voluntary st pension w.e.f. 1 May 2009.

However two different types of mechanisms have been introduced by PFRDA as far as pay out from New Pension Scheme

Pay out in NPS for Central Govt Employees :

At the time of retirement or at the age of 60 and when accumulation period ends an employee has the option to invest at least 40% accumulated wealth in purchasing an annuity plan from a life insurance company approved by IRDA and to take maximum 60% of as lump sum withdrawal.

Pay out in NPS for all citizens :

Voluntary NPS allows an investor, withdraw before age 60 at any point of time but has to invest at least 80% of accumulated wealth to purchase an annuity from a life insurance company approved by IRDA and 20% as lump sum withdrawal.

However, under voluntary NPS , when an investor exit at the age 60 from the system has to invest at least 40% of wealth in annuity and the remaining amount can be withdrawn as lump or as a phased withdrawal between the age 60 and 70 This Phased withdrawal is an additional facilities in voluntary NPS.

Benefits of Dividend Option over Growth in Mutual Funds

noreply@blogger.com (ram) — Sun, 11 Mar 2012 17:11:00 +0000

Mutual fund investments have usually two options: dividend and growth. The amount invested by you in mutual funds are used to buy stocks, bonds or other investments. Over the period of time, the value of investments and cash surplus held in a mutual fund scheme is reflected in its NAV (Net Asset Value).

The mutual fund scheme in which you have invested makes profits on selling some of these investments that has appreciated based on stock price movements. Over time, these provide cash inflow for the mutual fund that it can either choose to re-invest by making fresh investments (growth option) or payout as dividend to unit holders (dividend option).

Say, a new Equity mutual fund scheme was launched a year back and collected money from investors at Rs. 10 NAV under two options — dividend and growth. Today, the NAV of both the growth option and dividend option is Rs. 18. The fund manager decides to book profits in investments and share the same with its unit holders who have opted for dividend. So he announces 50 per cent dividend. i.e. Rs 5/- per unit.

If this mutual fund advertises this dividend announcement by quoting a future record date for attracting more investments, is it prudent to invest for getting the dividend at the time of investment itself?

Unfortunately, the answer for this question is No. The next day after the dividend record date, the NAV of this investment would drop to Rs. 13/-.

This is because a dividend from a mutual fund is nothing but a return of capital held by the fund scheme. The Rs. 18 NAV of the scheme with the dividend option, already included the distributable cash of Rs. 5/-, on distribution of which, as logic would suggest, the NAV reduced by an equal amount. Nothing is free in this world!

The NAV of the scheme with the growth option would remain at Rs. 18/- because the scheme didn’t distribute a dividend. An investor is no better off choosing the dividend option instead of the growth option. And, his purchase decision, triggered purely by the lure of quick returns through the dividend, is a misinformed one.

Every time a fund scheme announces a dividend, the same scenario will repeat, i.e. the NAV of the scheme will drop by an amount equal to the dividend amount. Within the same scheme, the NAV of the growth option will always be higher than that of the dividend option because the money is going back into the scheme and not given to investors. The reason for the difference in NAV between these two identically managed plans is that one keeps stripping money and dispatching it to investors while the other just re-invests any gains (income). It is this re-investment that has accumulated and appreciated over time, resulting in a much higher NAV today — a substantial capital gain.

So, Investors who only need long-term capital gain (wealth appreciation preferred over income) can choose the growth option. Such investors can still pay themselves a dividend when they want liquidity or when they feel the market is overvalued, by simply selling the requisite number of units!

On the other hand, investors who need income can choose the dividend option. The dividend amount should not be the sole deciding factor while investing, because technically a fund can declare high dividends by merely selling its assets, irrespective of whether it has made a profit or loss! So dividends need to be evaluated in conjunction with the total returns that the fund has been able to generate.

However, investment in the mutual funds with dividend option would be beneficial in two aspects. One is the tax treatment.

The following table illustrates the tax implications of dividends compared to capital gains. If you are going to hold your mutual fund units for over a year from the date of investing, capital gains have equal if not lesser tax outgo compared to dividends.

On the other hand if your holding period is less than a year, then you have to pay more short term capital gains tax as the amount equivalent to the dividend that was distributed in respect of mutual fund with dividend option,would be part of Net asset value in the case of growth option which is also taxable

The other is the benefit of tax exemption under Section 80C of IT act for the full amount invested in ELSS mutual fund with dividend option (Equity linked Savings Scheme) and yet getting back a portion of amount as dividend which would reduce your investment that is locked for 3 years (note : ELSS funds have three year compulsory locking period)

What is Human Life Value ?

noreply@blogger.com (ram) — Fri, 09 Mar 2012 15:36:00 +0000

Yes. It’s a price tag on human life. Every humanbeing is priceless to his family. But it becomes necessary to evaluate a human life in terms of money, in order to safeguard from under-insurance problems. Under-insurance at times leaves no trace of insurance when it fails to serve the purpose for what it was effected. Insurance on Human Life should be sought keeping in mind, the financial loss that the family would suffer in his/her absense. Instead of buying Life insurance policies as a tool for reducing tax liability, provision for old age, to venture into stock markets on a small scale etc, it would make sense if insurance is sought from the angle of economic replacement of human life value.
Human Life Value concept was founded by Dr. Solomon S. Huebner, the founder of ‘The American College of Life Underwriters’, in the 1920′s. HLV concept is used by various professionals like Underwriters, Courts, etc. for determining the economic value for a Human Life. For the victims of the ‘Terrorist attack of September 11, 2001′ on the twin towers, courts decided the amount of settlement based on this concept.
HUMAN LIFE VALUE of a earning member in the family could be defined as the amount that the family would require to retain the same standard of living in the absence of the earning member. This would be the maximum amount for which a person can seek insurance protection.
Human Life Value based on Income:

The first step towards computation of Human life value would be to determine the net annual income of the person after deducting the amount spent by him for his personal use. This amount will be the amount that he affords to his family annually. Let us assume that the person is 40 years of age and his annual income after deducting all his personal expenses sums up to Rs.3,60,000. So, in order to get this amount annually in the absence of this earning member, his family would need Rs.45,00,000 on his demise (This assumption is based on investment of Rs.45,00,00 as fixed deposit @ rate of 8% interest per annum).
However, the erosion money value due to inflation was not taken into account in this method.
Human Life Value based on expenditure:
The more complex calculation of HLV is based on expenditure that the family has to meet out after the earning member’s life. The factors such as age of life expectency of spouse, number of children and their dependancy period on the family, monthly household expenditure, cost of inflation, outstanding loans etc., are to be taken into account in the calculation of this type of HLV.
Of course, the disposable assets if any the family posesses, value of the same could be deducted from the total amount that family needs. Say, if the earning member left behind an asset valued at Rs.20 lakhs the same could be deducted from Rs.45 lakhs of capital requirement of the family worked out. So, as per our illustration, the family would require Rs.25 lakhs in addtion to the disposable asseet valued at Rs.20 lakhs, to earn an amount of Rs.30,000/- per month.
Type of Insurance :
Now, the type of life Insurance product that you want to choose in order to get the coverage of Rs.25,00,000/-, is an important decision.
The following will be the premium amount that you have to pay annually under different Life Insurance products. Well known insurance products in the indian market are Term Insurance, Pure Endowment Plans, and ULIP (Unit Linked Insurance Plans).

Which plan would you choose to get your life covered for Rs.25 lakhs ? Term insurance products seem to be cheapter than ULIP, Endowment etc. Is it so? Check this previous GConnect article that compares Term Insurance and ULIP.
The bottom line is one should get his life covered for sum that would serve the purpose of fulfilling all the financial needs of the family in his absence. Taking an insurance cover for a small amount that would not serve the purpose is as bad as not taking any life cover.

SMS and Email Alert facility for NPS

noreply@blogger.com (ram) — Fri, 09 Mar 2012 14:47:00 +0000

CRA has launched a new service called as SMS and Email Alert facility for the Subscribers under the New Pension System (NPS). As a part of this new facility, the Subscriber will be able to receive SMS and Email Alerts on the occurance of any one of the following events:

Generation of PRAN for Subscriber
Contribution Credit in the Subscribers PRAN

Terms and Conditions for SMS and E-Mail facility

1.1 Definition

In these Terms and Conditions, the following terms shall have the following meanings: "Alert/Facility" means the (services of providing the) customized messages with respect to specific events/transactions relating to a subscriber's Account sent as Short Messaging Service ("SMS") over mobile phone or email to the email account of the subscriber; "Subscriber" means the person who holds a Permanent Retirement Account Number (PRAN) opened by CRA and who is also IRA compliant; "CSP" means the cellular service provider through whom the Investor receives the mobile services. "CRA" means the NSDL who have been appointed as Central Recordkeeping Agency by PFRDA.

1.2 Availability

1.2.1 CRA at its sole discretion may discontinue the Facility at any time by providing a prior intimation through its website or any other medium of communication. CRA may at its discretion extend the Facility to investors who register mobile numbers originating outside India.

1.2.2 The Facility would be generated by CRA and will be sent to the subscriber on the mobile number or E-mail Address provided by the subscriber. Further, the time and the completeness of the Alerts content and delivery would be entirely based on the service availability of the service provider and its connectivity with other CSPs or the mail server availability of the respective websites. The Alerts are dependent on various factors including connectivity and, therefore, CRA cannot assure final and timely delivery of the Alerts.

1.2.3 The subscriber will be responsible for the security and confidentiality of his/her Mobile Phone/email account to be used for this Facility.

1.3 Process

1.3.1 This Facility provides information to investors over mobile phones and email ids for PRAN getting generated and the units getting allocated in Tier I and Tier II of the account, a day after the units get credited. These Alerts will be sent to those subscribers who have provided their mobile numbers and/or email ids to their nodal offices (like PAOs/DTOs/POPs etc.) while filling a PRAN application form.

1.3.2 The subscriber is duty bound to acquaint himself/herself with the detailed process for using the Facility and interpreting the Alerts for which NSDL is not responsible for any error/omissions by the subscriber.

1.3.3 The subscriber acknowledges that this facility will be implemented in a phased manner and CRA may at later stages or when feasible, add more features. CRA may, at its discretion, from time to time change the features of any Alert. The subscriber will be solely responsible for keeping himself/herself updated of the available Alerts, which shall, on best-effort basis, be notified by CRA through its website or any other medium of communication.

1.4 Receiving the information through SMS and email

1.4.1 The subscriber is solely responsible for intimating in writing to his/her nodal office/POP any change in his/her mobile phone number and/or email id. CRA will send the alerts only to the numbers/email id recorded in it system. Subscriber may also update the mobile number and email id through his/her secured log-in and opts for this facility.

1.4.2 The subscriber acknowledges that to receive Alerts, his/her mobile phone must be in an 'on' mode (reachable) as well as the email id must be 'active'. If his/her mobile is kept 'off' for a specified period from the time of delivery of an Alert by CRA or the email account is no more in active state, that particular information may not be received by the subscriber.

1.4.3 The subscriber acknowledges that the Facility is dependent on the infrastructure, connectivity and services provided by the CSPs /or the e-mail service provider within India. The subscriber accepts that timeliness, accuracy and readability of information sent by CRA will depend on factors affecting the CSPs and other service providers. CRA shall not be held liable for non-delivery or delayed delivery of Alerts, error, loss or distortion in transmission of information to the subscriber.

1.4.4 CRA will endeavor to provide the Facility on a best effort basis and the subscriber shall not hold CRA responsible/liable for non-availability of the Facility or non performance by any CSPs or other service providers or any loss or damage caused to the subscriber as a result of use of the Facility (including relying on the information for his/her investment or business or any other purposes) for causes which are attributable to /and are beyond the control of CRA. CRA shall not be held liable in any manner to the subscriber in connection with the use of the Facility.

1.4.5 The subscriber accepts that each Alert may contain certain account information relating to the subscriber. The subscriber authorizes CRA to send any other account related information, though not specifically requested, if CRA deems that the same is relevant.

1.5 Withdrawal or Termination

1.5.1 CRA may, in its discretion, withdraw temporarily or terminate the Facility, either wholly or in part, at any time. CRA may suspend temporarily the Facility at any time during which any maintenance work or repair is required to be carried out or incase of any emergency or for security reasons, which require the temporary suspension of the Facility.

1.5.2 Notwithstanding the terms laid down in clause 1.5.1 above, either the investor or CRA may, for any reason whatsoever, terminate this Facility at any time. In case the subscriber wishes to terminate this Facility, he/she will have to intimate his/her PAO/DTO/POP accordingly.

1.6 Fees

1.6.1 At present, CRA is levying no charge for this Facility on the subscriber/PAO/DTO/POP. The subscriber shall be liable for payment of airtime or other charges, which may be levied by the CSPs in connection with the receiving of the information, as per the terms and conditions between the CSPs and subscriber, and CRA is in no way concerned with the same.

1.7 Disclaimer

1.7.1 This Facility is only additional information for the investors and is not in lieu of the Transaction Statements required to be provided by the CRA to its clients on a yearly basis.

1.7.2 CRA shall not be concerned with any dispute that may arise between the investor and his/her CSP and makes no representation or gives no warranty with respect to the quality of the service provided by the CSP or guarantee for timely delivery or accuracy of the contents of each Alert.

1.7.3 The Subscriber shall verify the transactions and the balances in his/her account from his/her nodal office and not rely solely on Alerts for any purpose.

1.7.4 CRA will not be liable for any delay or inability of CRA to send the Alert or for loss of any information in the Alerts in transmission.

1.8 Liability

1.8.1 CRA will not be liable for any losses, claims and damages arising from negligence, fraud, collusion or violation of the terms herein on the part of the investor and/ or a third party.

What are all the charges for investing in NPS?

noreply@blogger.com (ram) — Wed, 07 Mar 2012 14:44:00 +0000

NPS is one of the low cost pension systems in the world. The cost structure is also very transparent and there is no hidden cost.

Some costs like CRA charges, often criticised as high at the initial stage, however, the same would decline with the increase in number of accounts.

The most significant is the fund management charges, which at present is 0.0009% based on assets under management.

Low cost means more amount for investment leading to higher accumulated wealth at the time of termination from the scheme.

Various charges under NPS-Government Scheme, All Citizens Scheme are shown here.

Why NPS is a Flop ?

noreply@blogger.com (ram) — Sun, 19 Feb 2012 17:19:00 +0000

Budget 2009-10 proposed to exempt the income of the New Pension Scheme (NPS) Trust from income tax and dividend distribution tax.

It also exempt the trust from paying the securities transaction tax on purchase and sale of equity shares and derivatives, steps that could lower the cost for NPS subscribers.

The finance minister also proposed allow self employed persons to participate in the NPS and avail the tax benefits.

As you are aware NPS was open to public on May 1 2009, and up to 50 percent of amount collected through NPS could be invested in stock markets the fund managers of NPS appinted by the Govt.

Reliance Capital, UTI, State Bank of India, IDFC, ICICI Prudential Life Insurance and Kotak Mahindra Bank are currently the fund managers in this pension product.

Finance Minister Pranab Mukherjee announced these measures to support the New Pension System (NPS) but will these measures help to re-vitalise the NPS ?

However, experts say there are few takers for the NPS, as it still continues to be under the exempt-exempt-taxed (EET) regime with the maturity amount being taxed unless the money is used for buying annuity in the same financial year.

This is unlike other competing products like Provident Fund (PF) and Public Provident Fund (PPF), which continue to enjoy the exempt-exempt-exempt (EEE) regime and not taxed at any stage.

That explains why only 800-900 non-government applications with a total investment of up to Rs 15 lakh have fallen in its lap since May versus Rs 2,500 crore invested by government employees, who have joined service after 2004.

Experts believe unless PF and PPF schemes are brought under similar tax structures, NPS is unlikely to pick up and nor will the benefits accrue to the stock market.

Experts say seventy per cent of Indians are under the age of 35. If you can channelise even a small proportion of their current earnings into equity market through NPS, it would mean long term and domestic money coming in.

It appears that NPS would still take time for the NPS to pick up.

But unless tax structures are brought at par with other tax saving schemes, there is little hope for the product.

Scheme preferences for Government Employees in NPS

noreply@blogger.com (ram) — Tue, 24 Jan 2012 14:41:00 +0000

Scheme Preference in Tier I:

As per the present guidelines of Pension Fund Regulatory and Development Authority(PFRDA), Scheme Preference is the Pension fund schemes option chosen by the subscriber for investing the pension contribution amount. As far as NPS subscribers who are working in Central/State Government are concerned, there is only one default scheme for Tier I. The scheme preference differs between NPS for Government Employees and NPS for other citizens as far as Tier I NPS is concerned. While other citizens are allowed to invest in all of the pension funds available in NPS, Government Employees are allowed to invest only in three Pension funds (LIC, SBI and UTI)

Default Scheme for Government Employees (applicable only for Tier I):

In the default scheme, the contribution is allocated to three PFMs, viz. SBI Pension Funds Private Limited, UTI Retirement Solutions Limited and LIC Pension Fund Limited in a predefined proportion and each of the PFMs will invest the funds in the proportion of 85% in fixed income instruments and 15% in equity and equity related instruments.

Scheme preference for Government Employees in Tier II:

For Tier II, the government subscriber has been given the flexibility to choose one out of six Pension Fund Managers(PFMs) and also the percentage in which the selected PFM will invest the funds.

The six PFMs are

ICICI Prudential Pension Funds Management Company Limited
IDFC Pension Fund Management Company Limited
Kotak Mahindra Pension Fund Limited
Reliance Capital Pension Fund Limited
SBI Pension Funds Private Limited
UTI Retirement Solutions Limited

What are Asset Classes?

Investment in New Pension Scheme by Government Employees in Tier II can be made based on his expected return at the cost of taking calculated risk. There are three asset classes which are known as Equity (E), Corporate bonds (C) and Government Securities (G).

Equity (E):

This asset Class meant for the investment in company shares which are listed in National Stock Exchange. Once the choice made by you for portion of your investment in this assest class, it will be invested only in companies, stock prices which are accounted for calculating the Index (NSE Index). In other words, the fund managers are allowed to invest only in flagship companies in order to safeguard the investments of the NPS susbscribers.

Corporate Bonds (B):

This asset class is the investments made in Bonds issued by Big Corporates such as LIC, IDFC, IFCI etc. The idea behind the investment in these bonds is to earn steady income in the form of interest or dividend. The investment made in this asset class is safer compared to Equity.

Government Securities (G):

This assest class consists of investments only in securities issued by Government by time to time. Of course we have to forego part of our expected additional return for the sake of safety of investment

What is Active Choice?

When a subscriber chooses Active Choice, he can specify the percentage in which his / her money is to be invested in the three asset classes detailed above. However, allocation in Equity cannot be more than 50%.

Wnat is Auto Choice?

A subscriber opts for Auto Choice, system will automatically calculate the asset allocation percentages based on the subscriber's age.

Entry load on Mutual funds to be abolished

noreply@blogger.com (ram) — Tue, 10 Jan 2012 17:21:00 +0000

Investments in mutual fundsmay not suffer deduction of ‘entry load’ for too long. In a move that will empower investors to determine the price they will pay for service received from a distributor, thereby reducing their cost of investing in mutual funds, the Securities and Exchange Board of India (SEBI) has asked fund houses to do away with entry load on all their schemes.

Entry load is the typical 2.25 per cent (maximum of 2.5 per cent) charge levied at the time of investing in mutual funds, mostly equity funds. While this may not seem like a conspicuous charge on paper, the levy goes to reduce the final number of units allotted to you. Such levy is almost entirely utilised by the fund house for paying the commission to the distributors for marketing their fund. In other words, a small portion of the money earmarked for investment — in the name of entry load — is paid to the distributor.

SEBI’s new proposals allow investors to directly make payments to the distributors for their services, instead of mutual fund houses deducting the same from the investment amount.

To provide an example: Had you invested Rs 10,000 in a fund which had an entry load of about 2.25 per cent and an NAV of, say, Rs 10 per unit, then, only 977.9 (10000/10.225) units would have been allotted to you, as the entry load of 2.25 per cent would have increased your cost per unit to Rs.10.225.

Under the new proposal, investors would be able to receive units for the entire amount of Rs 10,000 invested; they may have to draw a separate cheque in favour of the distributor towards a mutually agreed service fee.

This essentially means that an investor may have a choice of paying nil/small commission to an ‘no frills’ agent or go for a distributor who charges slightly higher fee, perhaps for other superior advisory service offered in addition. Viewed differently, investor will now be ‘aware’ of thecommission they pay; there would be no hidden marketing charges.

Reason behind the move

While this proposal is clearly aimed at allowing the investor to decide what to pay for the service received by him/her, the move may also eliminate gratuitous churning of the portfolio by investors. In an entry load regime, distributors typically benefit more every time a fresh investment is made. Hence, it was not uncommon for distributors to recommend a switch between funds, causing churning.

Now, under the new proposal, the commission to be received by a distributor may be uncertain; the only other key source of the agent’s income would be the ‘trail commission’ received from the fund house for retaining a customer’s investments. So the motive for recommending fresh transactions may be less.

Role of invester

Once this proposal comes into force, investors may be prompted to immediately scout for a no/lowcommission distributor. Beware! For one, you may be sold a fund with a poor track record or one on which the agent receives a higher ‘trail’ commission. That may not be the best fund for your portfolio. Please bear in mind that a consistent long term track record and a risk profile that suits your appetite should be the key factors that determine your investment choice.

As we have always maintained, in the Indian market context, an entry load of 2.5 per cent or acommission paid to the distributor is a small sum, compared to the 12-15 per cent annualised return that a good equity fund can easily yield.

Two, if commissions on MFs go down, products such as ULIPs may look attractive from a distributor’s point of view given their lucrative commission. Ensure that you are not sold an ULIP when you do not want one. ULIPs are long term insurance-cum-investment products. They generally build in expenses upwards of 10 per cent, in the initial years. This sum would be deducted from your investment amount.

So as an investor, what should be your response to this change?

As always, ensure that you choose a fund based on its track record. Expenses or commissions come next.

Do not be diverted into buying ‘other’ products if your objective is to buy a mutual fund

If you are a less-informed investor and need advice, do not hesitate to pay a decent sum to a good financial advisor/distributor. There are no free lunches.

If you are a well-informed investor, making your own investment decisions, you can apply for funds directly through their portals or approach any of the local offices of the fund house you want to invest in. This way there would be no commission. If you wish to make such an investment through your online broking account, you may do so; this would however entail paying a fee.

As a distributor has to now reveal the commission that he receives from the fund house for the product, ask him for the same. That way, you will know whether you are paying too high acommission or otherwise.

There has been no indication so far as to the implementation date of this proposal. There are also other grey areas in implementation of the same, especially on the distribution side, which too may have to be addressed.

Income Tax exemption for New Pension Scheme

noreply@blogger.com (ram) — Wed, 24 Jun 2009 17:23:00 +0000

The finance ministry is considering to extend tax advantage (EEE status) to the New Pension Scheme (NPS) in this year’s Budget, according to top government officials.

This will bring the government-sponsored pension scheme on a par with other long-terminvestment plans such as the Public Provident Fund (PPF), Group Provident Fund (GPF), Employee Provident Fund (EPF) and life insurance policies.

While all these plans are exempt from tax at all the three stages of investment — contribution, return and withdrawal — NPS is taxed at the withdrawal stage.

The Pension Fund Regulatory and Development Authority (PFRDA) has been asking for a level playing field for a long time. As per the regulator, the tax disadvantage is one of the biggest impediments in the acceptance of the NPS by the informal sector.

“We have been asking for an equitable tax treatment for the last two years. And this year as well we have made a request to the government to consider this in the upcoming Budget,” said PFRDA chairman D Swarup.

If the proposal becomes law, then in all likelihood pension schemes sold by the life insurance industry will also get the same treatment. At present, an investor gets tax benefit at the investing stage and not at the time of disbursement.

The NPS was launched first in 2004 for the Central and state government employees. This year in May, the regulator opened it for informal sector as well. Currently, there are approximately 6 lakh accounts.

NPS is mandatory for all the Central government employees (except armed forces) joining service after January 1, 2004. But the scheme for the informal sector is voluntary in nature and has attracted a lukewarm response.

In a country of over a billion, where almost 90 per cent people belong to the informal sector, the scheme has attracted only 350 investors in its first month. The regulator believes that EEE treatment will make the scheme more favourable.

source : The Indian Express

SBI introduces Micro SIP

noreply@blogger.com (ram) — Sat, 18 Apr 2009 17:25:00 +0000

SBI mutual funds, has launched equity-based Micro Systematic Investment Plan (Micro SIP) aimed at getting in low income households in rural and semi-urban areas to benefit from the long-term investment in ‘Equity’ as an asset class. This plan will be called SBI Chota SIP.

For monthly investment as low as Rs. 100, investors from low-income group as well as investors who intend to invest small portion of their savings would now be able to participate in capital markets and be a part of India growth story.

Micro SIP facility will be available in respect of four equity diversified schemes of SBI Mutual fund with effect from April 15, 2009. They are Magnum Balanced Fund, Magnum Multiplier Plus Scheme 93, Magnum Sector Funds Umbrella-Contra fund, and SBI Blue Chip fund.

The minimum investment amount will be Rs.100 and multiples of Rs.50/- thereof. The minimum redemption amount will be Rs.500/-. Minimum tenure of SIP will be 5 years.

The business snapshot

noreply@blogger.com (ram) — Mon, 30 Jun 2008 18:43:00 +0000

Now that you've mastered the mysteries of the Profit & Loss Account, let's move on to the Balance Sheet. This gives you a picture of the size of the company's assets and liabilities, and the sources and uses of the company's funds

Unlike the P&L account, which shows the profit or loss a firm has incurred over a period of time, the balance sheet is a snapshot of the firm at A POINT OF TIME. As on a particular date, the last date of the accounting period, the assets and liabilities of the firm are all added up and presented in the balance sheet. The capital and reserves are added to the liabilities side to balance the two sides. In other words, Capital + Liabilities = Assets.

To illustrate, let us take the Balance Sheet of Reliance Industries.

	As at 31st March 1999		As at 31st March,1998
	Rs.	Rs.	Rs.	Rs.
SOURCES OF FUNDS :
Shareholders’ Funds
Share Capital - Equity	933.39		931.90
Share Capital - Preference	252.95		187.95
Reserves and Surplus	11,183.00		10,862.75
		12,369.34		11,982.60
Securitisation/Advance Against Future Recievables Loan Funds		965.02		300
Secured Loans	5,477.64		2,736.78
Unsecured Loans	5,207.65		5,510.55
		10,685.29		8,247.33
TOTAL		24,019.65		20,529.93

APPLICATION OF FUNDS:

Fixed Assets
Gross Block	18,650.33		17,848.33
Less:Depreciation	6,691.93		4,944.47
Net Block	11,958.40		12,903.86
Capital Work-in-Progress	3,437.83		2,069.43
		15,396.23		14,973.29
Investments		4,294.59		4,282.33
Current Assets, Loans and Advances
Current Assets
Interest Accrued on Investments	25.61		21.07
Inventories	1,408.61		1,343.96
Sundry Debtors	457.10		642.72
Cash and Bank Balances	4,897.60		2,133.51
	6,788.92		4,141.26
Loans and Advances	1,676.26		991.05
	8,465.18		5,132.31
Less: Current Liabilities and Provisions
Current Liabilities	3,591.98		3,382.01
Provisions	544.37		475.99
	4,136.35		3,858.00
Net Current Assets		4,328.83		1,274.31
TOTAL		24,091.65		20,529.93
Significant Accounting Policies
Notes on Accounts

You'll notice it's divided into two broad sections- Sources of Funds and Application of Funds.

Sources of funds

What are the sources of funds? Obviously share capital is one of them. In the Reliance balance sheet, there are two types of share capital-- equity and preference. Equity shares are ordinary shares. Preference shares, on the other hand, are so called because they get preferential treatment when it comes to paying dividend. Preference shareholders are paid a fixed dividend, unlike ordinary shareholders, whose dividends vary according to how well the company has performed.

However, preference shareholders, because they opt for the security of fixed dividend payments also forgo capital appreciation -their shares are typically redeemed at a fixed price (often no different what they paid for it).

Profits retained by the business over the years are also a source of funds. These are included under the head "Reserves and Surplus". Loans, secured and unsecured, constitute the other source of funds. Secured loans are those in which the lender has a charge on the company's assets as security, while unsecured loans are those where there is no security, for example fixed deposits from the public.

There's yet another source of funds. You'll find, towards the bottom of the balance sheet, an item called Current Liabilities and Provisions, which are deducted from Current Assets. Current Liabilities are things like Sundry Creditors, or those to whom the company owes money. In other words, you owe someone money, but you haven't paid him yet. So he becomes a source of funds.

The other item, Provisions, is a bit trickier. These are sums set aside but payments have not been made. In other words, you need to pay income tax, wealth tax, dividend, leave encashment etc, and make provisions for them, but because you haven't yet paid these sums, they become a source of funds.

Uses of funds

Now we come to the applications side of the balance sheet. Here we have the uses to which all those funds, which have been sourced, have been put. There are two broad classifications--fixed assets and current assets.

Fixed assets are things like plant and machinery. Total depreciation on these assets (see article on P&L account) is deducted from gross assets to arrive at net assets or net block. To that is added capital work-in-progress, that is, the projects going on at the balance sheet date. Investments in stocks or bonds are another way in which funds can be used. And lastly we have current assets, so called because they form part of the working capital cycle which transforms raw materials to finished goods. Current assets consist of inventory, people who owe the company (sundry debtors) and cash and bank balances. Loans and advances given to others is also a use for funds.

How do you use this information?

Now you have all this information about where the company has got its money from and how it has used it. But what use is it? You'll notice there are two columns in the balance sheet, with the previous year's figure also being given. Comparing the two sets of figures leads to some insights.

For instance, in the Reliance balance sheet, the amount of secured loans has gone up from Rs2736cr to Rs5477cr. How did it use this money? The balance sheet shows that part of it went towards increasing gross block, part towards the higher capital work-in-progress a bit on inventories and a large part was held in cash and bank balances. You can make a similar analysis for every source and use of funds, checking out how funds were sourced and how it was spent during the year. For instance, if a company siphons out money by giving loans to associate companies, the balance sheet will tell that to you.

A snapshot as on a particular date

One important caveat. The balance sheet is a snapshot, as on a particular date. For instance, if you had checked the balance sheet a few days earlier, the cash and bank balances may not have been so high. Or a company may have repaid a loan just for a few days to show lower indebtedness as on a particular date. Doing up the balance sheet in this fashion is known as window dressing. So now that you can read a balance sheet, keep a pinch of salt handy.

Back to basics

noreply@blogger.com (ram) — Sun, 29 Jun 2008 19:45:00 +0000

The profit & loss account

Introduction

If you own shares, you'll remember that the company sends you a booklet called an annual report just before the annual general meeting. Most of the time, all you've done is admired the glossy pictures before adding it to the pile of newspapers for the raddiwala.

That's a pity, because a company's annual report can be a great source of information, helping you to decide whether to stay invested in the company. At the very least, it'll help you ask some tough questions to the management at the AGM.

We know the problem. You'll be thinking that's a lot of unreadable stuff! Not to worry, accountants are in business by making it difficult for ordinary people to understand accounts! All of us can learn to read accounts. We'll show you how.

The profit & loss account

At the heart of the annual report is the Profit & Loss Account. Accountants call it the P&L account to show familiarity, as well as to make it difficult for ordinary people to understand what they're talking about.

No company can exist for long by continuously making losses, and the P&L account shows the extent of profit or loss made by the company in a particular year. To illustrate, let's take the Reliance Industries annual report for 1998-99.

	1998-99		1997-98
	Rs.	Rs.	Rs.	Rs.
INCOME
Sales		14,553.26		13,403.78
Other Income		607.55		335.60
Variation in Stock		(152.43)		368.28
		15,008.38		14,107.66
EXPENDITURE
Purchases		190.32		14.19
Manufacturing and Other Expenses		11,500.52		11,206.93
Interest		728.81		503.55
Depreciation	1,776.66		1,460.27

Less : Transfered from General Reserve (Refer Note 3, Schedule 'O'){	921.62	855.04	792.95	667.32
		13,274.69		12,391.99
Profit Before the year		1,733.69		1,715.67
Provision for the year		30.00		63.00
Profit for the year		1,703.69		1,652.67
Add:Taxation for the earlier years		-		(85.67)
Balance brought forward from last year		1,047.89		662.79
Investment Allowance(utilised)		-		-
Reserve written back		-		36.00
Amount available for Appropriation		2,751.58		2,265.79

APPROPRIATIONS
Debenture Redemption Reserve	204.50		64.47
General Reserve	1000.0		752.65
Interim Dividend	23.39		10.33
Proposed Dividend	350.16		326.81
Tax on Dividend	40.86	1,618.91	63.64	1,217.90
Balance carried to Balance Sheet		1,132.67		1,047.89
Significant Accounting Policies
Notes on Accounts

You'll notice there are two main heads - income and expenditure. Simply put, the difference between the two is the profit (if income exceeds expenditure) or loss (if expenditure exceeds income). And losses, as you know, are bad.

Income

The total income is broken down into several heads-sales, other income, and variation in stock. Obviously, a company's sales will be its main source of income, so that item doesn't need much explaining. A source of confusion can be the fact that sales are sometimes called gross sales and at other times net sales. The difference is the amount of excise duty paid, and net sales is merely gross sales less excise duty. Net sales is a better indicator of how much the company is selling, because the excise duty goes to the government. Clearly, higher sales help the company earn higher profits.

"Other income" is accountantspeak for all those items of income which do not relate directly to the company's sales. This could include dividends and interest received by the company from its investments, the profit on sale of investments or assets, sale of scrap and other such items. Some companies put service income, like money earned by repairing or servicing, in this category. Basically, the thing to remember is that other income is very often, but not necessarily, income from activities distinct from the company's main activity. Sometimes such other income is one-off in nature, such as the profit from selling assets. So if you want to predict the company's future income, you'll have to leave out this kind of one-off income.

The third item, variation in stock, reflects the fact that a company always carries some inventory, which is nothing but unsold stock on a particular date. The company has already incurred some expenditure in producing this inventory, which is reflected in the expenses part of the P&L account. So the value of the closing stock should also be included to give the correct picture of the profit. However, from this closing stock the value of the stock at the beginning of the accounting period must be subtracted, since that was included as closing stock during the previous accounting period. That sounds complicated, but just remember that the variation in stock is actually nothing but closing stock less opening stock of finished goods and stocks in process. Why not raw material stocks? Raw material stocks are not included here because there is an item "raw material consumption" in the expenditure section of the P&L account.

Expenditure

The expenditure part of the P&L obviously has purchases and manufacturing expenses. In fact, all the costs that go into making the things the company sells. But that's not all. Interest costs incurred on the company's debts are also included here. Further, there's an item known as depreciation, which is nothing but a notional estimate of the wear and tear of the equipment used by the company. The logic is that a company needs to set aside a sum annually so that it can buy new machinery when it is needed. Clearly, keeping costs in check will add to the bottomline.

You'll notice that there's something known as schedules against the items in the P&L account. These are nothing but more detailed break-ups of these items. For instance, in the RIL P&L account, schedule L gives details of all the manufacturing expenses, such as salaries and wages, sales and distribution expenses, expenses on power, fuel, and administrative expenses like rent, insurance, etc.

Profit and EPS

Deducting expenditure from income gives the profit before tax. When the amount set aside by the company for tax purposes is deducted, we get the all-important net profit figure. Adding the balance brought forward in the account last year, we get the amount available for appropriation, which is nothing but the way the profit is divided. One chunk is paid to equity shareholders as dividend, one part goes towards paying dividend on preference shares, while the rest goes to statutorily required reserves, such as the reserve for redeeming debentures, and to the general reserve, which bolsters the company's net worth, or the amount of shareholder's funds.

A last word about EPS, which is earnings per share. This is a figure analysts love to talk about. EPS is calculated by dividing net profit by the number of shares allotted by the company. It shows how much each share of the company has earned during the year.

Also important is to check out the trends, by comparing last year's figures with those of the current year. Trends are important because they show the way the company is going. For instance, a company may still be earning profits, but the amount gets smaller and smaller each year. Nobody in his right mind would invest in such a company.

That wraps up the basics of the P&L account. Investors can use this information not only to find a company's earnings, but also how it has arrived at these earnings. Did sales increase? Were expenses kept in check? Was interest expenditure too high? The answers to these questions will be provided by reading the P&L account.

Graduating in Risk Premium

noreply@blogger.com (ram) — Sat, 28 Jun 2008 18:43:00 +0000

In case you have reached this vantage point after having understood the basics of 'risk premium', we offer you our hearty congratulations on having made such outstanding progress!

Now, picking up the thread from where we left off, investors get compensated only for the market risk that they bear. Market risk is the only risk that cannot be reduced through diversification in your portfolio (by including a set of stocks from different businesses), like business risk can.

However, the influence of the market varies for various stocks. Some stock movements are exaggerated compared with market movements while others are subdued.

We understood last time that the 'beta' of a stock measures this relative movement of a stock vis-?is the market. Hence, 'beta' measures the tendency of the stock to participate in the market movement.

Let's work this out using an example...

Hyper Ltd., Tracker Ltd. and Sober Ltd. are three stocks that trade in the stock market of Shareland. Sharex is the stock market index in Shareland. Hyper has a beta of 1.3 while Tracker has a beta of 1. On the other hand, Sober has a beta of 0.7.

First stop, what do these values mean?

Hyper's beta value of 1.3 indicates that it is far more sensitive to market movements than Tracker and Sober. In other words, if the market as measured by Sharex goes up by 10%, Hyper will go up by 13%. Tracker will go up as much as the market, i.e. 10%, while Sober gains a mere 7% in relation to the market.

Who commands the lower risk premium?

After having come so far in the lesson, we expect that you will flip this situation to its negative face and look at the situation when the stock market in Shareland drops by 10%.

In this case, Hyper drops the most (by 13%) as it has a higher beta of 1.3. Since Tracker has a beta of 1, it drops by 10%, the same as the market. On the other hand, Sober drops by a mere 7%.

A higher beta means higher risk and hence a stock with higher risk needs to command a higher 'risk premium'. And obviously, since Hyper reacts in a manner true to its name for every drop/gain in the market, it is the riskiest stock and should command the highest premium, followed by Tracker with Sober being the least risk option of the three.

Moving on to CAPM

So if the risk premium commanded by the stock market is x%, then the risk premium that investors should demand for a particular stock is beta times x%. CAPM states that the expected return on a stock is the sum of a `risk-free rate' and `stock beta times market risk premium'.

This, in essence, is the capital asset pricing model (CAPM). After all, why should anyone expect to earn more by investing in one stock as opposed to another? You need to be compensated for doing badly when times are bad. The stock that is wont to do badly just when you need money in trying times is a stock you should hate, and there had better be some redeeming virtue or else who would want to hold it?

How is beta calculated?

Oh, we are not going to give you some longwinded formula. After all these days, you do not need to know how a computer works to actually use one. So, we shall never trouble you with formulae, but just explain the concept.

An analyst calculating the beta of a stock obtains the historical returns of that stock over a period and then compares them using 'linear regression' to the returns on the index. It is just enough for most of us to know that linear regression is a statistical tool for estimating beta.

Some pertinent questions to ask at this stage

Q: Is the beta of a stock constant?

A: The beta of a stock can change over time as the stock's characteristics transform. For example, a stock moving from the B1 group to the A group sometime back would have changed the beta of the stock. After all, the underlying liquidity of the stock would have changed as A group stocks have this carry forward mechanism that attracts a whole host of speculators.

Q: Can a low beta stock be more volatile than a high beta stock?

A: Interestingly, a low beta stock could be more volatile than a high beta stock. Remember, the beta measures only the systemic risk or the influence of the market on the stock whereas a stock on its own might have a very high unsystemic risk because of the risk associated with the company's business.

Wrapping up today's spoils

The key insight of the capital asset pricing model is that higher expected returns go with the greater risk of doing badly in bad times.

Beta is a measure of a stock's tendency to move with the market. Stocks with high betas tend to do worse in market downturns than those with low betas.

Our advice: If your heart has a high beta level, invest in a stock that has a low beta!

Back to basics

noreply@blogger.com (ram) — Sat, 28 Jun 2008 04:45:00 +0000

The profit & loss account

Introduction

The profit & loss account

	1998-99		1997-98
	Rs.	Rs.	Rs.	Rs.
INCOME
Sales		14,553.26		13,403.78
Other Income		607.55		335.60
Variation in Stock		(152.43)		368.28
		15,008.38		14,107.66
EXPENDITURE
Purchases		190.32		14.19
Manufacturing and Other Expenses		11,500.52		11,206.93
Interest		728.81		503.55
Depreciation	1,776.66		1,460.27

Less : Transfered from General Reserve (Refer Note 3, Schedule 'O'){	921.62	855.04	792.95	667.32
		13,274.69		12,391.99
Profit Before the year		1,733.69		1,715.67
Provision for the year		30.00		63.00
Profit for the year		1,703.69		1,652.67
Add:Taxation for the earlier years		-		(85.67)
Balance brought forward from last year		1,047.89		662.79
Investment Allowance(utilised)		-		-
Reserve written back		-		36.00
Amount available for Appropriation		2,751.58		2,265.79

APPROPRIATIONS
Debenture Redemption Reserve	204.50		64.47
General Reserve	1000.0		752.65
Interim Dividend	23.39		10.33
Proposed Dividend	350.16		326.81
Tax on Dividend	40.86	1,618.91	63.64	1,217.90
Balance carried to Balance Sheet		1,132.67		1,047.89
Significant Accounting Policies
Notes on Accounts

Income

Expenditure

Profit and EPS

Chasing the elusive 'Risk Premium'

noreply@blogger.com (ram) — Sat, 28 Jun 2008 04:40:00 +0000

Welcome to the next leg of our 'Risk Premium' journey

Having come so far in the lesson, one would assume that you have understood that the risk premium demanded by equity investors on their investment is forward-looking, as it is based on the expectation of returns. You have also understood that risk premium increases with higher volatility of expected returns.

Hence, we saw our friend Mr Savvy Investor choose an investment option, based not just on expected returns but expected returns adjusted for the risk. So, take a deep breath and think back on what trait Mr Savvy Investor was displaying when he made the requisite calculations.

He was avoiding risk! He was unwilling to take on additional risk unless he was compensated for taking that risk.

Such risk avoiding behaviour is the cornerstone of rational investing. Textbooks state that a rational investor is risk averse, and that rational investors measure reward using expected return and risk calculated as variance.

Risks borne by an equities investor

Time to take a quick look at the broad classes of risks borne by an equity investor:

As you figured out while reading "Taming the risks" , the risk borne by equity investors can be classified as two types - systemic risk, which is market risk and unsystemic risk, which is risk borne specific to a business. We also discovered that unsystemic risk can be reduced by diversifying investments across a basket of stocks representing various businesses. However, systemic risk is something that we have to live with.

Can an investor expect compensation for bearing both market and business risks?

If your answer is yes, you probably are asking for a little too much. Remember that, as an equity investor, you can spread your investments across a basket of stocks to reduce your business risk to zero. In fact, there are extensive studies that show that even a portfolio with eight stocks reduces unsystemic risk to zero. Hence, the only risk that an equity investor can demand a premium for is the systemic or market risk.

Now that we know what type of risk you can demand compensation for, how do we go about measuring it? Simple, the risk premium for systemic risk needs to equal the risk premium for the market as a whole. After all systemic risk exists because of the pervasive influence of the market.

But just the risk premium for the market is not enough

What have we missed? Let's see... Assume that a new government came to power at the Centre and the Sensex went up by 8% in two days...

Would you think HLL, Infosys and HFCL all went up by 8% each?
If you think that they all went up by different percentages, then which one do you think went up the most?

We have all seen that every stock posts different gains for the same gain in the Sensex. Stocks like HLL do not rise as fast as the market nor do they drop as fast. Infosys on the other hand posts gains higher than the market. HFCL, we are all well aware, moves sharply higher whenever the market moves higher while falling more sharply than the market in the downswings.

In other words, the influence of the market forces is different on different stocks. Hence, we cannot just settle for the risk premium commanded by the market. We need to measure how the market affects a particular stock.

The 'beta' factor

'Beta' measures the factor of influence of the market on a particular stock. Financial expert William Sharpe worked out a method for doing just this (calculating the beta of a stock). Many of you would have come across the concept of 'capital asset pricing model' or CAPM.

CAPM makes a fundamental assumption that the historic volatility of stock prices will be mimicked in the future too.

Next time, we will unravel how CAPM and beta help us get a fix on this elusive risk premium. Until then, I leave you with a thought to ponder:

Do you think a high beta stock should have a higher risk premium or a lower risk premium?

What is right risk premium?

noreply@blogger.com (ram) — Sat, 28 Jun 2008 04:34:00 +0000

Risk is not always a bad thing

What is the second thing that strikes your mind when you hear the word 'equity' or 'stock'? (If 'risk' is the first thing that flashes across your mind, then you seem to have had an overdose of emphasis on risk in our recent school write-ups. Maybe it is time for you to learn more about how stocks offer great returns over the long run and the 'power of compounding'.)

If 'risk' is the second thing to take the dias, you are ready to take the next few steps in understanding this concept better. And just in case 'risk' was the last thing to chance upon your mind, we suggest that you start right at the beginning of these series.

What is equity risk premium?

Last time we understood that though risk is the chance of loss, it is equally a matter of choice. 'Equity risk premium' is the leveller that makes risky investment options attractive. Now it is time to put a finger on 'equity risk premium'.

We saw that Mr Savvy Investor settled for investing in the stock since he expected to make 13.4% extra returns over the 30% return on government bonds in three years. In other words, equity risk premium is forward looking.

If equity risk premium is forward looking and based on expectations, how do we know that we have settled for the right 'risk premium? Or how do we know that the 'risk premium' adequately compensates us in case the returns go against expectations?

A theoretically applicable method is to look at returns associated with all possible situations. Then assign probabilities to these possibilities and get a fix on the 'expected' return. In the end, the expected return needs to be compared with the risk-free return to evaluate if the 'risk premium' is adequate enough.

A little lost? Back to our good friend - Mr. Savvy Investor.

Our thought experiment

Small Cement Company (SCC), Efficient Cement Company (ECC) and Big Cement Company (BCC) are three cement companies.

SCC has small capacity and hence its earnings improve dramatically after cement prices cross a threshold price. ECC, on the other hand, has a very efficient process and hence its earnings improve sharply with any rise in cement prices. The biggest of them all, BCC, is not so sensitive to cement prices, thanks to its size. In other words, BCC's bottom line moves in a more sober manner to the changes in cement prices.

Time to make one simplistic assumption

Let us assume that the earnings of these companies are sensitive to only cement prices. Hence, cement prices determine the returns from investing in these stocks.

Mr. Savvy Investor needs to pick the best investment option from these three companies.

Luckily, a cement expert and a stock market analyst have made life for our friend a little simple.

The cement expert has assigned the following probabilities for the change in cement prices over last year. The stock market analyst has given his assessment of the expected returns from these three stocks for the respective changes in cement prices.

Event	Probability	Returns
Event	Probability	SCC	ECC	BCC
5% decline	20%	-5%	0%	5%
Flat	30%	+10%	+10%	+10%
5% increase	40%	+25%	+20%	+15%
10% increase	10%	+35%	+30%	+25%

Mr Savvy Investor had to make a wise choice with just these details.

He calculated the average returns that he expected to make for each company. He had the probabilities associated with each return. Hence, all he had to do was multiply each probability with the associated return and add all of them together. For example, the average return that one can expect on SCC worked out to:

20%*-5%+30%*10%+40%*25%+10%*35% = 15.5%. This way, he calculated the expected returns for these three companies as follows:

	SCC	ECC	BCC
Expected Returns	+15.5%	+14%	+12.5%

Do you think the choice was very easy for Mr Savvy Investor? After all, he just worked out that SCC has the highest expected returns.

Think again, for our wise investor has chosen BCC over the others.

To find out why, cast a glance upon the main table again. The returns on SCC can swing from -5% to 35%, an extremely volatile stock indeed, with returns moving in a range of 40% from -5% to 35%. On the other hand, ECC is little less volatile as its returns fluctuate within a band of 0% to 30% - a range of 30%.

Finally, BCC is found to be a relatively steady stock. The worst case return on BCC is found to be 5% although the best case return, at 25%, is less than the returns of the other two. Anyway, this is a comparatively small range of 20% fluctuation in return.

Factoring in volatility of return

Mr Savvy Investor made another smart back of the envelope calculation. He divided the expected returns for each of these stocks by the range of possible returns. Look at what he got from his crude calculation...

	SCC	ECC	BCC
Exp Returns/Range	0.3875	0.467	0.625

In other words, Mr. Savvy Investor calculated his expected returns for every unit range of return that the stock could swing. A neat approximation to what the statisticians will call 'deviation from the mean'. BCC turned to have the highest return for every unit of risk.

The answer became obvious to Mr. Savvy Investor- BCC was the best investment option.

Of course, he might discover that the risk premium built into the 12.5% return from BCC' investment is not a good enough premium. But that is a different story altogether.

A recap on this lesson

We will revisit these calculations later. It is time now to take stock of what we have learned about 'equity risk premium' so far:

This premium is forward looking in nature, as it is based on 'expectation' of return.
Expected returns could vary within a wide range. A higher range of return implies a higher gap between expected return and the actual return, thereby increasing the uncertainties associated with the return.
We also understood that in case the range of returns from an investment in a stock is very large, then investing in the stock is more risky. However, this was a crude way of pinning the volatility of stock returns.
After all the more likelihood of stock returns swinging from our expected returns, the more uncertain the actual returns we realise in the future. Look at our example, SCC returns are expected to be 15.5% but the eventual returns could swing any where from a -5% to 35% depending on how cement prices turn out.
Statistically, the deviation from the expected return is a measure of the volatility of the stock returns.
It is not enough to select the stock with the highest 'expected' return. It is important to select a stock that has a higher return per unit of risk.

Of course, this essentially explains the concept of 'equity risk premium'. The higher the volatility or uncertainty, the higher the risk premium sought by the investor.

Getting the 'risk premium' right - the next step

Now that we understand all these concepts, how do we get around the issue of obtaining a fix on this risk? After all, everybody invests based on expectations. How can we figure out today how much the returns will deviate from expectations in the future?

Academicians have worked on evolving methods that help us approximate and get a better fix on these future uncertainties. Next time, we will grapple with the issue of getting a fix on 'risk' and demanding the right 'risk premium'.

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