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Interest Rates and Bond Prices

2012-05-01T12:05:22Z

Confused about the complex nature of Bond Prices? The value of a bond is inversely proportional to the current standing of interest rates. The relation between the two may not quite seem palpable at first. Here’s an easy to understand guide that helps you grasp the reason why bond prices plummet downwards when interest rates go up.

For Instance

Let’s begin with an example. Do you have a laptop at home? Of course you do. Let’s say, you purchased a laptop for a hefty lump sum of Rs. 1 lakh. I’m sure a lot of thought went into the purchase of this gadget. You’ve made sure you bought the best you could within your budget margins. However, a month down the lane a colleague gets his hands on a better model or a higher version of the same model at the same price of Rs. 1 Lakh. You feel the pinch.

What do you do?

You drag yourself back to the computer peripheral shop you picked your laptop from. You argue with the dealer indicating the unfairness of the deal you were given. The dealer informs you that the laptop you purchased a month ago is now being sold at an MRP of Rs. 95,000. You feel the pinch, once again.

What exactly happened there?

What your dealer did is he further embellished the previous deal you were at the receiving end of. He pumps in a slightly better model with better features and offers it at the same rate. In doing so he is able to allow a discount on the previous model featured in the deal. The price drops down to Rs. 95,000.

This scenarios is much too similar to the inter dependency of bond prices and interest rates. Every time the market offers better interest rates and by better we mean higher interest rates, the price of previous versions of bonds that have comparatively lower interest rates plunge downwards. In a similar fashion, when interest rates are estimated to witness a sudden drop, all existing bonds with higher interest rates experience a further increase in their prices. Think of it as a situation where a car manufacturer strips his creation off a couple of its features just so as to maintain a steady pattern of prices.

Still on hazy grounds?

Here’s a numerical example. There exists a certain bond which is issued for Rs. 10,000 for five years along with a 5% coupon/ interest rate which is levied once in six months. Along comes a day when the interest rate rises to 6%.

If you decide to sell this bond now, you will see that no one will be willing to purchase it when the bond is fetching rates that are 1% below market rates. It’s 5% against 6%.

What you can do instead is sweeten the deal. Tweak the rates to align it with market rates. You won’t be able to do anything about the interest rate on your bond as it stays fixed at 5%. What you can do is give a new price albeit a lower one for your bond and still make profit.

Suppose: -

You have a yearly fee structure of Rs. 500 (Rs. 10,000 X 5%). It must equal a 6% payment.

When you get down to calculate, you will find that the surface value of the bond should be reduced to Rs. 8,333/-. This matches the fixed payment of Rs. 500 to a 6% profit on the buyer’s investment.

Rs. 8,333 x 6% = Rs. 500

The Conclusion

If interest rates experience a sudden drop rather than a peaking, you should go ahead and sell your bond at a premium over face value. The obvious reason behind this is the fixed interest rate will be higher than the market rate at any given point of time!

Should you invest in Manganese Ore India Ltd. (MOIL) IPO?

2011-12-11T04:47:21Z

Facts about Manganese Ore India Ltd. (MOIL):

MOIL operates 10 mines, six located in the Nagpur and Bhandara districts of Maharashtra and four in the Balaghat district of Madhya Pradesh.
The company’s reserves of manganese ore are reported to be around 69 million tonnes.
As on September 30, 2010, the company’s reported Cash and Bank balance is around Rs 1700 Crores.
The company was granted the Mini-Ratna public sector company status in 2008.
The company was the largest producer of manganese ore by volume in India in Fiscal 2008.
Net sales Rs.9693.95 million and PAT Rs.4656.20 million in FY 2010, EPS of 27.72 for FY 2010.

A detailed report on MOIL prepared by India Infoline can be read here.

BID/OFFER PROGRAMME
Offer Opens	26th November 2010
Offer Closes (QIBs)	30th November 2010
Offer Closes (Retail and Non-Institutional Bidders)	1st December 2010

PRICE BAND	340 to 375
Minimum Bid quantity	17 Equity shares and in multiples of 17 Equity shares thereafter
Maximum Bid quantity	527 Equity shares for retail and eligible employees.

I think the offer is reasonably priced and hence one can invest in this IPO to make some money. Besides, its a good long term bet as well.

What do you think? Will investors make money by subscribing to MOIL IPO?

More money in your bank account from April 2010

2010-04-04T08:13:17Z

Yes, from 1st April 2010, you’ll earn more money for every rupee that you deposit in your bank account. Though the interest rate of 3.5% p.a. on your bank balance remains the same, what has changed is the method of calculating the interest. Let me explain.

First, let’s try to understand how interest was calculated on your bank balance before 1st April 2010.

Most banks in India used to pay interest on minimum balance between the 10th and the last day of the month. So, suppose you deposited Rs. 1 lakh in your account on the 1st of March and withdrew it on the 31st of the same month, you won’t receive any interest on it. This is because, the minimum balance between 10th March (Rs. 1 lakh) and 31st March (Rs. 0) was zero.

Though you don’t get any interest on your money, the banks make sweet profit by lending these free funds at high interest rates. This gross cheating continued for a long time as most retail depositors never bothered to understand how interest was calculated on their bank balances and hence, never complained.

However, things have changed post 31st March 2010.

According to the new RBI guideline, banks are supposed to pay interest on daily minimum balance in the account. Hence, as per above example, if Rs. 1 lakh stayed in your account for 30 days, you’ll earn interest at the rate of 3.5% p.a. for those 30 days.

Hence, as the title states you’ll earn more money in your savings bank account from 1st April 2010.

What you don’t know about ‘Highest NAV Guarantee’ plans

2010-03-26T07:23:41Z

You know that ‘Highest NAV Guarantee’ plans give you the guarantee of highest NAV but what you don’t know is that they don’t guarantee the highest returns. Confused? let me explain.

How ‘Highest NAV Guarantee’ works

Almost all the companies offering such plans use an dynamic hedging investment strategy called Constant Proportion Portfolio Insurance (CPPI). In this strategy, the fund manager constantly allocates funds between debt and equity to ensure that you get the previous highest NAV. Because there is a guarantee involved, higher proportion of the portfolio has to be invested in debt. In the first year your investment will be split between debt and equity to ensure that you get an assured NAV of Rs. 10. In the next year, suppose the equity markets fall, the portfolio will hold due to investments in debt. If the markets were to rise and suppose the NAV reaches Rs. 12, then the funds will be moved from equity to debt to assure NAV of Rs. 12.

Also, to get this guarantee, you need to bear an additional cost over and above the fund management charge further eating away from your return.

Plans offering ’Highest NAV Guarantee’

There is a slew of such products launched by practically all the insurance companies operating in the market. These plans are as follows:

LIC Wealth Plus
ICICI’s Pinnacle
SBI Life Smart UlipAEGON Religare Wealth Protect Plan
Birla Sun Life Platinum Plus-III
Bajaj Allianz Max Gain
Tata AIG Apex Invest Assure
Reliance Highest NAV Guarantee Plan

Should you invest?

The way these plans are aggressively marketed (with limited information) by the insurance companies, any investor would get lured. After all who won’t like to have great returns without any risk? But we have to remember that there are no free lunches in this world. Since there is limited risk, these schemes would never give returns similar to pure equity schemes. Besides, most of these plans are for minimum of 7-10 years. In that period returns from equity are bound to be positive and greater than that from these schemes.

So if you are an investor who wants to protect his capital and is happy with small upside, then you can definitely opt for these schemes. For all others, its better to keep away.

SEBI reduces NFO period and allows ASBA

2010-03-23T09:37:03Z

SEBI has reduced the New Fund Offer(NFO) period from existing 30-45 days to 15 days. It has also allowed the use of Application Supported by Blocked Amount(ASBA) facility while applying to new fund offers.

Before trying to understand what exactly this means and how would it benefit the investors, let’s look at the the scenario that exists currently.

A typical new fund offer from any mutual fund house lasts from anywhere around 30 to 45 days. This means that you have 45 days to apply to the offer. If you are one of the early birds who decides to invest as soon as the NFO opens, your money stays parked with the fund house for 45 odd days without earning you anything before it gets invested. However, during this time, the fund house earns a decent interest income on your money.

To ensure that you are the one who earns interest on your money and not the fund house, SEBI has mandated the following changes:

Allowing use of ASBA facility
Application Supported by Blocked Amount(ASBA) is a facility wherein the money you intend to invest in an NFO stays in your bank account and consequently earns you the interest. The money leaves your account only when units are allocated to you. While in your account, this amount stays blocked ensuring that you cannot use it for any other purpose. However, if you wish, you can still apply using cheques/demand drafts.
Reduction in NFO period
This will benefit the investors who opt not to use the ASBA facility and invest using cheques or demant drafts. If you invest using cheques or demand drafts, your money will be transferred to the fund house immediately thereby causing loss of interest to you during the NFO period. By reducing the NFO period to 15 days, SEBI has reduced the notional loss of interest to such investors.
Allotment of units should be within 5 business days after NFO closure
Within 5 business days after the closure of NFO, the fund houses should ensure they do the following:
- Allot the units
- Dispatch the statements
- Make all schemes (except ELSS) available for repurchase/sale/trading.

These rules would be applicable to all NFOs that launch on or after 1st July 2010.

Since the last couple of years, SEBI has been working hard to protect the interests of mutual fund investors. Abolition of entry loads, making mutual funds available through alternate channels like stock brokers, etc. have definitely benefited the investors. The new NFO regulations continue this trend.

What else do you think needs to be changed to make NFOs more efficient?

ULIPs better than Mutual Fund + Term Plan Combination

2010-03-23T09:37:16Z

It has long been a common belief amongst the investing community that for the same life insurance cover, Mutual Fund + Term Plan combination gives a better return than an Unit Linked Insurance Plan (ULIP). While this was true till recently, the change in charge structure and the subsequent abolition of service tax on charges in ULIP have tilted the scale in favour of ULIP.

The new ruling on ULIP charges

The ULIP charges will be capped at 3% for a policy with tenure of up to 10 years, of which fund management charges cannot be more than 1.5%. For policy tenures above 10 years, the charges cannot exceed 2.25%, of which fund management charges cannot exceed 1.25%. These regulations are effective from 1st January 2010.

This new ruling will mean that the amount invested from the premium would be higher and subsequently the returns would be higher than before.

Comparison of ULIP v/s Mutual Fund + Term Plan combination

*Annual Investment of Rs. 35000/- for 20 yrs. with life cover of Rs. 10 lakh*
	Total Inv. p.a. (Rs.)	Inv. in Term Plan p.a. (Rs.)	Assumed Gross Yield	Expenses	Net Yield	Fund at the end	Death Benefit	Net Gain (excl. Death Benefit)
ULIP before IRDA ruling	35000	NA	6.00%	3.50%	2.50%	907250	1000000	207250
ULIP after IRDA ruling	35000	NA	6.00%	2.25%	3.75%	1049748	1049748	349748
MF + Term Plan	35000	1780	6.00%	2.25%	3.75%	1000106	2000106	335706
# Death benefit in ULIP is higher of either sum assured or fund value at the end. * Assumptions: Fund category is equity in both MF and ULIP; Gross yield is assumed at 6% and age of insurer = 30years. # Source: ICRA Online Research

Looking at the table above, we can deduce the following:

Under the new regulations, the gain from ULIP is higher than that from MF + Term Plan combo if you survive the tenure of the policy. For the same life cover (RS. 10 lakhs), the mortality charges of ULIP totals to Rs. 22916 while the premium for Term Plan totals to Rs. 35600. Coupled with reduced charges, ULIPs turn out to be a winner.
In case of death during the tenure of the policy, MF + Term Plan combo beats ULIP. This is because in case of MF + Term Plan combo, the nominee is able to retain the maturity value of Mutual Funds while he also gets the cover provided (Rs. 10 lakhs). While in case of ULIP, only the higher of fund value or sum assured is will be given to the nominee.

The recent Union budget has proposed to waive off the service tax on ULIP charges which will improve the returns further.

So what will you opt for?

Tax Rules for Mutual Funds

2010-03-23T09:37:25Z

Know exactly what you need to pay as tax when you invest in Mutual Funds. Click here to view updated tax rules for mutual funds as per the provisions of Finance Bill 2010. The document gives details of tax related to short term gains, long term gains, dividend income, dividend distribution, tds, etc on Mutual Funds for resident individuals, firms, HUF, NRI, etc.

Download the PDF file here.

Direct Tax proposals in the Union Budget 2010-2011

2010-03-23T09:37:42Z

The Finance Minister, Mr. Pranab Mukherjee, has proposed the following changes in Direct Taxes for individuals:

Income tax slabs for individual taxpayers to be as follows:

Income upto Rs 1.6 lakh Nil

Income above Rs 1.6 lakh and upto Rs. 5 lakh 10 per cent

Income above Rs.5 lakh and upto Rs. 8 lakh 20 per cent

Income above Rs. 8 lakh 30 per cent
Deduction of an additional amount of Rs. 20,000 allowed, over and above the existing limit of Rs.1 lakh on tax savings, for investment in long-term infrastructure bonds as notified by the Central Government.
Besides contributions to health insurance schemes which is currently allowed as a deduction under the Income-tax Act, contributions to the Central Government Health Scheme also allowed as a deduction under the same provision.

These changes would help increase the money in your pocket, though not by much

Click here to read the highlights of budget.

Get Capital Protection + Growth with Birla Sun Life Capital Protection Oriented Fund Series 1

2010-03-23T09:37:52Z

You’ve worked hard to earn money. And you want investments that keep your money safe. Traditional deposits come to mind first. But with safety, wouldn’t you also like to get better returns?

Birla Sun Life Capital Protection Oriented Fund Series 1 is designed to keep your money safe and at the same time allowing a small portion of your money to participate in equity growth. That too, with tax efficient returns as compared to traditional deposits.

The illustration below explains how this scheme is designed to work:

Greater Safety, Rated AAA (so) by CRISIL

Birla Sun Life Capital Protection Oriented Fund – Series 1 has passed the mandatory requirement of getting a rating from CRISIL, by recieving the AAA (so) rating which is the highest safety rating given by CRISIL. Hence, the debt part of your money will be invested in Government bonds, bonds that are approved by CRISIL or bonds that are rated AAA / AAA(so) by CRISIL; which increases the safety of the debt portion of your investment.

Returns, That Too Tax-Efficient!

Here’s the best part of investing in this fund. When investing in traditional deposits, you can end up paying as much as 30.9% tax on your returns. However, in Birla Sun Life Capital Protection Oriented Fund – Series 1, you may have to pay as little as 10.3% tax as long term capital gains. You can ask your tax advisor how to take advantage of triple indexation which could further reduce your tax liability.

This is a good investment for people with very low risk appetite who always want their capital to be safe. Since only 10% is invested in equities, the upside is also limited. Though something is always better than nothing.

The subscription to this fund is open upto 5th March 2010. You can download the form here.

How To Invest At A Price Lower Than The Market Price? Rupee Cost Averaging

2010-02-26T13:16:04Z

Is it really possible to invest at a price lower than the market price? The answer is Yes, it is possible and that too in a perfectly legal way, by following the age-old principle of Rupee Cost Averaging.

Rupee Cost Averaging is a really useful concept in the science of investment. Let us try to understand it.

In this diverse world of investment, there are a few things which are common amongst all the investors. Every investor (including you and me):

wants to buy more when the prices are low and less when the prices are high
does not know when the prices are actually low and when they are actually high

Point no. 2 ensures that the point no. 1 is never achieved. Systematic Investment Plans (SIP) help solve this problem. Rupee Cost Averaging works in full force in an SIP.

In an SIP you commit a fixed sum of money to be invested periodically (monthly, quarterly, etc.). Hence, when the markets are volatile (as they are right now), you end up taking full advantage of rupee cost averaging. When the markets are low, you buy more units for the fixed amount and when the markets are high, you end up buying fewer units for the same fixed amount. This process ensures that the average cost of units is lower than what it would have been if you would have invested in lumpsum. This is what is called Rupee Cost Averaging.

Lets try to understand it with an example.

Suppose you have Rs. 10,000/- to invest. You have two ways to invest it. Either invest the entire amount in lumpsum or invest it in 10 equal installments of Rs. 1,000/- each.

If you invest in lumpsum and assuming the NAV of the scheme you are investing in is 20, you’ll be able to buy 500 units.

Alternatively, if you breakup your 10k in 10 installments, assuming a volatile market, your investments would be as under:

Time (months)	Amount Invested (Rs.)	NAV (Rs.)	Units Purchased
1	1000	20	50
2	1000	19	53
3	1000	24	42
4	1000	19	53
5	1000	16	63
6	1000	17	59
7	1000	16	63
8	1000	21	48
9	1000	18	56
10	1000	22	45
Total	10000	19.2	529

As you can see from the above table, your average cost is 19.2 and you end up buying 529 units as against 500 units when you invested in lumpsum. The additional 29 units is due to rupee cost averaging.

Though you have seen the benefit of rupee cost averaging, its important to note that rupee cost averaging has a positive impact only in a volatile market. If the market is going secularly upwards, you are better off investing in lumpsum.

Income upto Rs 1.6 lakh	Nil
Income above Rs 1.6 lakh and upto Rs. 5 lakh	10 per cent
Income above Rs.5 lakh and upto Rs. 8 lakh	20 per cent
Income above Rs. 8 lakh	30 per cent