Investment Products

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Welcome to our fourth day on Investing Advisery Certification Preparation.

I hope members are getting some gyan in the process of learning.

Todays topic is Investment Products

Broadly we cover four products here:

Small Saving Instruments

Fixed Income Instruments

Alternate Investments

Direct Equity

Many of you might already be knowing all these.

So, sit back and relax and use this 1 - 2 hours as a revision.

The way of functioning of an Investment adviser is different from that of a Portfolio Manager.

A Portfolio Manager or a Fund Manager uses bottom-up approach..

i.e he starts by selecting specific stock and securities first

and then moves up to build a portfolio.

A Financial Adviser will use a top-down approach

i.e he starts with financial goals, returns expected and risks involved etc.

and bottom down to specific securities and stocks.

An investment adviser's primary function is to give asset allocation function in the form of financial advisory services.

In some cases, the financial adviser can extended to recommend specific products

For Example, he may also be engaged in implementing the financial plan.

A Financial adviser can implement the plan only if ..

it is done through an independent arm of their firm

or

by a completely different firm that they may own.

Let us begin with Small Saving Instruments

Small Saving Instruments

These are offered by Post offices and select banks.

Popular schemes are:

1. Public Provident Fund (PPF)
2. Senior Citizens’ Saving Scheme (SCSS)
3. National Savings Certificate (NSC)
4. Post Office Schemes and Deposits

There was a committee established..

Committee for Comprehensive Review of National Small Savings Fund (NSSF)

NSSF recommended that the interest rates of these products are dynamic and should reflect prevailing market rates.

Hence, the return rates are linked to G-sec rates of similar maturity with a spread of 25 basis points (bps).

These rates are announced in April every year.

Rates will remain same as prevailing at the time of entry ..

for the entire duration of the investment till maturity ..

irrespective of the revision in subsequent years.

Only PPF rates are truly dynamic because the changes are reflected every year.

Public Provident Fund (PPF)

Instituted in 1968.

Objective of the PPF is ...

to provide a long term retirement planning option to those individuals who may not be covered by the provident funds of their employers or may be self-employed.

It is a 15-year deposit account.

Can be opened with a designated bank or a post office.

A person can hold only one PPF account (except an account in the name of a minor child to whom he or she is a guardian).

HUFs and NRIs are not allowed to open PPF accounts.

Minimum deposit amount of Rs. 500 and maximum of Rs. 1,50,000.

Subscription should be in multiples of Rs. 5.

Subscriptions can be paid in one lump sum or in installments not exceeding 12 in a financial year.

Interest is calculated on the lowest balance available in the account between 5th of the month and the last day of the month.

Total interest in the year is added back to PPF only at year end.

Account matures after expiry of 15 years from the end of financial year in which the account was opened.

One withdrawal in a financial year is permissible from seventh financial year.

Maximum withdrawal can be 50% of balance at the end of the fourth year or the immediate preceding year, whichever is lower.

Loan facility out of the amount standing to the credit in the account between the third financial year to the fifth financial year.

PPF is a exempt-exempt-exempt (EEE) product.

National Savings Certificate (NSC)

NSCs are issued with tenors of 5 years and 10 years.

The interest on these instruments for 2014-15 is 8.5% for the 5-year bond and 8.8% for the 10-year bond.

Interest is compounded half-yearly and accumulated and paid on maturity.

Certificates can be bought by individuals on their own account or on behalf of minors.

NRI, HUF, Companies, trusts, societies, or other institutions are not allowed to purchase the NSCs.

Certificates are available in denominations of Rs. 100, 500, 1000, 5000, and 10000.

Minimum purchase is Rs. 500 without any maximum limit.

80c benefit

No TDS

NSCs can be transferred from one person to another with the consent of a designated official of the post office under certain situations.

Premature encashment is allowed only in case of death of the holder.

Nomination is allowed in the certificates. No nomination for minor.

Certificates are also accepted as collateral for taking a loan. The government has recently enabled holding NSCs in demat form.

Senior Citizens’ Saving Scheme (SCSS)

Only senior citizens of age 60 years or above on the date of opening the account.

The scheme can be held in individual capacity or jointly with the spouse.

The age restrictions apply only to the first holder.

NRIs, PIOs and HUF are not eligible to invest in this scheme.

The term for the scheme is 5 years.

A one-time extension of three years is allowed, if applied within one year of its maturity.

Maximum limit of investment is Rs. 15 lakhs.

Interest rate applicable on the scheme for 2014-15 is 9.2% p.a. payable quarterly

Post Office Schemes and Deposits

Broadly there are three key schemes from post offices.

Post Office Monthly Income Scheme (POMIS)

Provides a regular monthly income to the depositors.

Term is 5 years.

Minimum amount of investment in the scheme is Rs. 1500

Maximum amount is Rs. 4.5 lakhs for a singly held account and Rs. 9 lakhs of the account is held jointly.

Multiple accounts are allowed but aggregate amount held in the scheme across all post offices cannot exceed the maximum permissible limits.

Premature withdrawal of the invested amount is allowed after 1 year of opening the account.

If the account is closed between 1 and 3 years of opening, 2% of the deposited amount is deducted as penalty.

If it is closed after 3 years of opening, 1% of the deposited amount is charged as penalty.

Post Office Time Deposits (POTD)

Similar to fixed deposits of commercial banks.

Terms of one year, two years, three years and five years.

Account can be held singly in individual capacity or jointly by a maximum of two holders.

Minimum deposit amount is Rs. 200. There is no maximum limit

Interest rates

One Year 8.4% Two Years 8.4% Three Years 8.4% Five Years 8.5%

Post Office Recurring Deposit

Can be opened by resident individuals, and a maximum of two people can hold an account jointly or on either or survivor basis

An individual can hold any number of RD accounts, singly or jointly.

Deposits can be made at a minimum amount of Rs. 10 per month and in multiples of Rs. 5 thereafter for every calendar month. There is no maximum limit.

The maturity amount with interest is paid at the end of the term. Interest is taxable.

Deposits have to be made regularly on a monthly basis, and penalties apply for nonpayment of instalment.

Fixed Income Instruments

Three type of bonds are popular

Government securities Corporate bonds Company deposits

Government Securities

Popularly called G-Secs.

Issued by the RBI on behalf of the government

Represent borrowing of the government, mostly to meet the deficit.

What is this: Deficit?

Deficit is the gap between the government’s income and expenditure.

G-secs are issued through auctions that are announced by RBI from time to time.

Banks, mutual funds, insurance companies, provident fund trusts and such institutional investors are large and regular buyers of G-secs.

In order to buy G-secs, retail investors have to open a constituent SGL (CSGL) account with their bank or any other holder of SGL (Securities General Ledger) accounts.

The CSGL account is held as part of the accounts of the offering bank.

In this CSGL Account, G-secs are held as electronic entries in demat form.

The minimum investment amount is Rs. 10000.

The price at which the retail investors are allotted G-secs as non-competitive bidders will be the weighted average price of the successful bids in the auction.

There is no cumulative option in a G-sec.

Interest is paid out on pre-specified dates into the designated bank account of the investor.

Interest is not subject to TDS but is fully taxable.

Retail investors may have to hold the G-secs to maturity.

G-secs can be offered as collateral for taking a loan from a bank.

These are less liquid.

So trading and selling in these by retail investors would be difficult.

Inflation-Indexed Bonds

Category of government securities issued by the RBI which provides inflation protected returns to the investors

Bonds have a fixed real coupon rate which is applied to the inflation adjusted principal on each interest payment date

On maturity, the higher of the face value and inflation adjusted principal is paid out to the investor.

Wholesale Price Index (WPI) is the inflation measure that is considered for the calculation of the index ratio for these bonds..

Inflation-Indexed National Saving Securities-Cumulative 2013 is one such product.

Binimum investment was Rs.5000 and the maximum Rs. 500000 per applicant.

Bonds were issued in the form of a credit to the Bond Ledger Account (BLA) and a certificate is issued to the holder.

Corporate Bonds

Issued by private and public sector companies

Tenors ranging from two years to 15 years.

More popular tenors are 5-year and 7-year bonds.

Mutual funds, insurance companies, and provident funds through a private placement of securities are popular buyers.

Bonds of all non-government issuers.

Hence they come under the regulatory purview of SEBI.

Compulsorily credit-rated and issued in the demat form.

Highest credit rating of AAA are safest.

Rating BBB are seen as having a high credit or default risk.

The bond is usually issued at its face value, say, Rs. 100 and redeemed at par, the same Rs. 100.

The frequency of the interest payment could vary, from monthly, to quarterly and annual.

Some bonds could feature a cumulative option where the interest is not paid out to the investor periodically but instead re-invested and paid out along with the principal at maturity.

Infrastructure Bonds

Financial institutions like the Industrial Development Bank of India (IDBI), India Infrastructure Finance Company Ltd. (IIFCL) and National Bank for Agriculture and Rural Development (NABARD) offer these products.. 80c deduction eligible.

Terms of the issue such as tenor, rate of interest and minimum investment may differ across the bonds

Infrastructure bonds are compulsorily credit rated, and can be issued in the demat

Do not carry any Govt guarantee.

Interest from these bonds is taxable.

Bank Deposits

A bank fixed deposit (FD) is also called as a term or time deposit.

Fixed bank deposits offer higher returns than savings accounts as the money is available for use by the bank for a longer period of time.

Interest on an FD can be paid into the depositor’s savings bank account at a predefined frequency.

duration of deposits can range from 14 days to 10 years though FDs longer than 5 years are not very common.

Special 5-year bank FDs are eligible for tax deductions up to a maximum amount of Rs.1 lakh.

Lock-in period of 5 years and have to be added back to the taxable income in the year of redemption.

Alternate Investments

These are investments whose risk and return structures differ from the traditional asset classes such as equity and debt.

Diverisification because of low-correlation with the other investment products.

Greater volatility in returns, longer investment horizons and lower liquidity for better returns

Illiquid and therefore it is difficult to determine the current market value of the assets.

Derivatives, structured products, real estate, gold, commodities, private equity and art/collectibles are the most common alternate investments.

Derivatives and Structured Products

Derivative = A financial product whose value is derived from another

A derivative is always created with reference to the other product, also called the underlying.

Risk management tool used commonly in transactions where there is risk due to an unknown future value.

Hedging

When an investor has an open position in the underlying, he can use the derivative markets to protect that position from the risks of future price movements.

Speculation

A speculative trade in a derivative is not supported by an underlying position in cash, but simply implements a view on the future prices of the underlying, at a lower cost.

Arbitrage

If the price of the underlying is Rs.100 and the futures price is Rs.110, anyone can buy in the cash market and sell in the futures market and make the riskless profit of Rs.10. This is called arbitrage.

Futures

A futures is a contract for buying or selling a specific underlying, on a future date, at a price specified today, and entered into through a formal mechanism on an exchange. The terms of the contract (such as order size, contract date, delivery value and expiry date) are specified by the exchange.

Options

Options are derivative contracts, which splice up the rights and obligations in a futures contract. The buyer of an option has the right to buy (in case of “call”) or sell (in case of “put”) an underling on a specific date, at a specific price, on a future date. The seller of an option has the obligation to sell (in case of “call”) or buy (in case of “put”) an underlying on a specific date, at a specific price, on a future date. An option is a derivative contract that enables buyers and sellers to pick up just that portion of the right or obligation, on a future date.

Other products

Real Estate Gold Commodities Private Equity and Venture Capital

Category of Alternative Investment Funds

Funds may seek registration under these Regulations as category I, II or III funds.

Category I funds invest in start-ups, SMEs, social ventures, infrastructure or other sectors designated as economically and socially desirable by the government or regulators. They are closed-ended funds with a minimum tenure of three years.

Category II funds are those that do not fall under categories I or III and do not take borrowings for other than operational requirements. Category II funds will be closed-ended funds with a minimum tenure of three years.

Category III funds are those that undertake complex trading strategies including investment in derivatives. Category III funds may be open or closed-ended.

International Investments

Investors can choose to invest in securities in international markets. The advantage of investing in such securities comes from the portfolio diversification benefits from exposure to global markets. Investors also get access to products that are still not available in India.

Art and Collectibles

Art objects, collectibles and precious stones are costly and illiquid investments that are difficult to value and authenticate. The market is small, with collectors spread over a wide geographical area. Investors have to be knowledgeable and well net-worked to know the market to be able to buy and sell these products. In the absence of regulators and regulations, chances of fraud are high.

Direct Equity

IPO and FPO Ownership Rights Residual Claim Reserves and Net Worth Limited Liability Returns are not fixed Market Indicators Fundamental Analysis and EIC Framework EIC = economic (E) industry (I) and company (C) factors

Valuation Measures Price

Price-Earnings Multiple Market price per share/Earnings per share Price to Book Value (PBV) Dividend Yield Technical Analysis

Related Lessons

• National Pension Scheme (NPS)
• Sovereign Gold Bonds
• Tracking Banking data with Spreadsheets
• Asset Allocation and Investment Strategy
• Investment Adviser and Regulatory Environment

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