Tuesday, March 31, 2009

Bond Glossary

The Bond market is currently abuzz and is attracting heavy investments from investors because of the safety and capital preservation they offer. Bonds are similar to bank deposits with a few minor differences.

Let us have a look at some of the common terms used in the Bond Markets

Convertible Bonds:
These can be converted into the shares of the issuing company at a particular time.

Coupon Rate:
This is the interest received on the principal amount invested by us. It is generally paid half yearly or annually.

Current Yield:
It is the annual rate of return on the bond’s price

Face Value:
This is also called the Par value. This is the maturity amount that the bond issuer agrees to pay the investor

Default Rate:
It is the percentage of companies under a particular rating that have defaulted in making payments to its investors.

Interest Rate Risk:
This is the risk of change in price of the bond due to interest rate fluctuations in the market. Interest rates and bond prices are inversely related.

Yield to Maturity:
This is the rate of return that you get if you hold the bond till maturity. The return includes coupon payments as well as the maturity value. Change in yield reflects change in price of the bond and they are inversely related.

Yield Spread:
This is the difference between the yields of two bonds. Generally a bond’s yield spread is determined by calculating the difference between the bond’s yield and the yield on government securities.

Zero Coupon Bonds:
These are bonds that do not pay any interest. Instead, these bonds are issued at a discount and the difference between the face value and the issue price is the investors gain.

The next article would be on the aspects to be checked before investing in Corporate Bonds.

Happy Investing!!!!!

Sunday, March 29, 2009

Life Insurance Cover – Policy Lapse & Revival

Under the current economic scenario many of us are tightly placed when it comes to our finances. Many of us are in a worser situation that the others. Some of us are even unable to pay their life insurance policy dues. Under such testing times it is our prime responsibility to ensure that our insurance policies remain intact and do not get lapsed.

What is a Lapsed Policy?

The insuring company provides us the insurance policy based on the premium amount we pay them on a regular basis. This can be monthly or quarterly or half yearly or even annual.
A policy lapse means that the life insurance contract between the insurer and the insured (YOU) is terminated.

When does a policy lapse?

As long as we pay our dues on time the policy remains in force. The moment we stop paying our premiums the policy lapses and the insurance cover provided by the policy becomes nullified. A lapse occurs when premiums are not paid even during the grace period. The life cover continues during the grace period whose duration varies based on the type of policy and premium payment frequency.

What is the Grace Period offered by Insurance Companies?

The grace period offered to us differs on the policy type and the premium payment frequency. Let us take 3 major categories of policies and analyze the available grace time.

1. ULIPs that are 3 years old or less

For ULIPs that have been in effect for three or less years and that have a regular premium paying system, the grace period offered by the companies is usually one month. Once this period is over the policy lapses. But, during the grace period the cover continues. So if a claim is made during the grace period, the nominee would get the benefits.

2. ULIPS that are more than 3 years old

ULIPs that have been in effect for more than 3 years, assume a paid up value since an investment corpus is already accumulated from the premiums paid in the previous years. This means that even if further premiums are not paid, the policy continues so long as the fund value covers the expenses that the insurance company incurs in managing your fund.

3. Traditional Insurance Plans

In case of traditional policies like term plans, money back plans or endowment plans etc the insurers give a grace period of about a month or upto a maximum of 3 months. The cover continues during this period. If the premium is not paid by the end of this period, the policy lapses and the life cover ceases.

What can we do if a policy lapses?

Most insurance companies have an option wherein we can revive the policy by paying a small penalty amount. Even after the grace period is over, we can pay our premiums with a small penalty which the company takes as charges for not paying the premium on time and revives the policy.

Since insurance is an important aspect of our financial plans, it is very important that we do not delay our premium dues and pay them on time…

Thursday, March 26, 2009

Some Common Financial Terms - Part II

U.S. Treasury Bill

A negotiable debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of one year or less. U.S. Treasury Bills are exempt from state and local taxes. These securities do not pay a coupon rate of interest, and the interest earned is estimated by taking the difference between the price paid and the par value of the bond, and calculating that rate of return on an annual basis. Treasury Bills are considered the safest securities available to the U.S. investor, and so the yield on these securities are considered the risk-free rate of return. also called Bill or T-Bill or Treasury Bill.


A physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be.
More generally, a product which trades on a commodity exchange; this would also include foreign currencies and financial instruments and indexes.


One who buys and sells securities for his/her personal account, not on behalf of clients.
An investor who holds stocks and securities for a short period of time (a few minutes, hours or days). The goal is to profit from short-term gains in the market. The stock selection is generally based on technical analysis or charting which relate only to the stock price rather than a fundamental evaluation of the company as a business. The IRS offers some tax benefits to traders: they can deduct their interest expense without itemizing, and seminar costs can be deducted as well as home office expenses in connection with investing.

Amortization of premium

Charges made against the interest received on a debt in order to offset a premium paid for the debt. Thus, with each periodic payment, a debtor is not only paying back interest, but also part of his or her premium. This leads to higher periodic payments than in the case when only interest is paid out. However, a payment schedule which includes premium amortization makes debt management easier, especially if the principal is large. While paying just the interest each period will lead to a low outflow of cash each month, the debtor might not save enough to pay the principal. Thus, amortizing the premium each period also reduces the credit risk of the debt, since the creditor gets some part of the principal each time period, as opposed to allowing a debtor to forfeit on all of it at the maturity of the loan. Amortization of premium is a common feature in cases when a person or company takes on a large amount of debt at one time, such as a mortgage.

Forward deal

A transaction consisting of a purchase or sale (often of foreign currency) with settlement to occur at a specified future date. Such a transaction will state the specific amount of the asset to be delivered at the specific time, as well as the unit price at which it will be delivered.

Secured bond

Bond backed by collateral, such as a mortgage or lien, the title to which would be transferred to the bondholders in the event of default. The most common form of secured bonds are mortgage bonds. These bonds are backed by real estate or physical equipment that can be liquidated. These are thought to be high-grade, safe investments. Other bonds are secured by the revenues created by projects. If an issuer in default has both secured and unsecured bonds outstanding, secured bondholders are paid off first, then unsecured bondholders. Naturally, because unsecured bonds carry greater risk than secured bonds, they usually pay higher yields.

Credit score

A measure of credit risk calculated from a credit report using a standardized formula. Factors that can damage a credit score include late payments, absence of credit references, and unfavorable credit card use. Lenders may use a credit score to determine whether to provide a loan and what rate to charge.

Cash pooling

A cash management technique employed by companies holding funds at financial institutions. Cash pooling allows companies to combine their credit and debit positions in various accounts into one account, and includes techniques like notional cash pooling and cash concentration. Notional cash pooling has the company combine the balances of several accounts in order to limit low balance or transaction fees. Cash concentration or zero balancing has the company physically combining various accounts into one single account.

Online banking

A system allowing individuals to perform banking activities at home, via the internet. Some online banks are traditional banks which also offer online banking, while others are online only and have no physical presence. Online banking through traditional banks enable customers to perform all routine transactions, such as account transfers, balance inquiries, bill payments, and stop-payment requests, and some even offer online loan and credit card applications. Account information can be accessed anytime, day or night, and can be done from anywhere. A few online banks update information in real-time, while others do it daily. Once information has been entered, it doesn't need to be re-entered for similar subsequent checks, and future payments can be scheduled to occur automatically. Many banks allow for file transfer between their program and popular accounting software packages, to simplify record keeping. Despite the advantages, there are a few drawbacks. It does take some time to set up and get used to an online account. Also, some banks only offer online banking in a limited area. In addition, when an account holder pays online, he/she may have to put in a check request as much as two weeks before the payment is due, but the bank may withdraw the money from the account the day that request is received, meaning the person has lost up to two weeks of interest on that payment. Online-only banks have a few additional drawbacks: an account holder has to mail in deposits (other than direct deposits), and some services that traditional banks offer are difficult or impossible for online-only banks to offer, such as traveler's checks and cashier's checks.

Index arbitrage

A strategy designed to profit from temporary discrepancies between the prices of the stocks comprising an index and the price of a futures contract on that index. By buying either the stocks or the futures contract and selling the other, an investor can sometimes exploit market inefficiency for a profit. Like all arbitrage opportunities, index arbitrage opportunities disappear rapidly once the opportunity becomes well-known and many investors act on it. Index arbitrage can involve large transaction costs because of the need to simultaneously buy and sell many different stocks and futures, and so only large money managers are usually able to profit from index arbitrage. In addition, sophisticated computer programs are needed to keep track of the large number of stocks and futures involved, which makes this a very difficult trading strategy for individuals.

Financial Terms - Part I
Financial Terms - Part III
Financial Terms - Part IV
Financial Terms - Part V
Financial Terms - Part VI

Four Reasons to Buy Gold

For ages gold has been one of the most sought after investment option for people. Be it investors like us or women of the household, gold has been one of the top priorities. Gold analysts have been boasting of the potential returns gold can provide over the past few years. Gold prices have been in an upswing ever since the market started to go down. The price of gold was Rs. 9,000/- for 10 grams in 2007 and Jan 2008 it was more than Rs. 10,000/- Last month the price of gold was nearly Rs. 15,000/- for the same quantity 10 grams. This is the all time high the price of gold has touched. Even now our gold analysts are continuing with their buy advice.

Gold is the only asset class that has provided consistent positive returns over the years. Especially in such testing times it has outperformed all other asset classes including the stock markets and real estate. Analysts feel that the price of gold would touch Rs. 18,000/- for 10 grams by the end of this year 2009.

Below are 4 compelling reasons for us to consider gold as an investment option for this year.

The Global Economy would remain affected

The world economy is in serious trouble and is likely to remain the same in the forthcoming months. The global growth forecast for this year is less than 1%. This is slowest growth forecasted in the global economy. We expected the growth to be around 2% for this year last year but our forecast proved to be wrong. A realistic estimate would be around 0.5 to 1%

In such difficult times gold becomes an automatic choice for our investors. Investors are searching for safe havens for their investment and with the kind of capital preservation gold offers; it is the number one choice. Some top mutual fund managers are worried about the trend in the market. Investors are buying gold like there is no tomorrow. This has further impacted the slowing economy and stock markets.

Because of the activity in the Gold ETF markets and the commodity markets the price of gold is constantly going up and a price of around 17,500 – 18,000 seems to be very possible.

US Dollar may depreciate against global currencies

The price of gold and the value of the dollar have an inverse relationship. If the value of the dollar drops, more dollars would be required to buy the same quantity of gold. So the value of gold stays unchanged but the devaluation of the dollar pushes its price up. If the dollar declines against other currencies it would decline against gold as well. This negative correlation may not be so evident on a daily or weekly basis but this would be very significant when checked on the long run.

Some analyst’s world wide feel that the US government may resort to printing more money in the coming months to tide over the financial crisis. This may have a negative impact on the economy. This could push up inflation and cause the price of the dollar to slide further. This would naturally push the price of gold further upwards.

Crude oil prices could bounce back to $65 a barrel

Gold and crude oil prices always move hand in hand. At least that is the general trend over the years. When the price of oil goes up it leads to high inflation which in turn makes gold an attractive investment option.

In July 2008 we saw oil touch an all time high of $147 per barrel and then it started slipping. The fall in crude prices was because of heavy drop in demand in the second half of 2008. In spite of this correction and its price reaching around $40 per barrel now, gold is still going up.

Analyst’s world wide feel that the price of oil may bounce back and reach around $65 - 70 per barrel. This puts gold in a sweet spot. It will be a good hedge against deflation if the economy does not improve and at the same time, it would be a good investment option to counter inflation. Either ways the price of gold would go up.

Global Demand for Gold would Exceed its supply

The demand for gold is around 3500 tonnes in a year. This includes gold required for jewellery, the commodity markets etc. but the production of gold is only around 2500 tonnes which brings us to a situation where there is a straight excess demand of nearly 1000 tonnes. Also gold mining countries worldwide are cutting down on their production owing to fears of the global recession. This would further fuel the demand for gold and its price would continue the upward movement.

What should we do now?

Don’t buy gold right away. Experts are expecting a correction in gold prices due to profit booking. Also there is a certain seasonality in the price of gold. Usually gold prices tend to peak out in March and then fall a bit before resuming its upward journey. So buy only 10-15% of what you plan to invest in gold and then wait for the correction. Once the correction happens, buy more. Buy in a staggered manner and do not invest all your money in one shot.

Also remember the importance of asset allocation. No asset class should have an inordinately large part in your investment. Decide on proper asset allocation and make sure that the fluctuation in prices of one asset does not affect the value of your portfolio heavily. An ideal allocation for this precious yellow metal would around 15% of your portfolio’s worth.

Happy Investing!!!

Saturday, March 21, 2009

National Pension Scheme

Of late, the National Pension Scheme (NPS) is one of the most talked about topics among people of our country. The NPS is a new initiative by the government of India to help us.
Retirement is something that every person who is earning needs to plan for. Once we cross the age of 60, our earning potential goes down and we are dependent on our savings for our sustenance. So it is advisable to save some money in our retirement corpus so that we can have a comfortable old age. Unfortunately, for most of us, apart from EPF (Employee Provident Fund) we do not have any saving instrument to save for our retirement. In countries like the US we have Social Security and hence the whole burden of survival after retirement does not fall on the person. But in India we do not have such a feature.
To overcome this problem, the government of India has come up with this NPS.

What is NPS?

NPS is a retirement saving option that can be availed by all citizens of this country. This functions more or less like a ULIP. Our money would be invested in the equity markets and also the debt market. The minimum investment to begin with is Rs. 6000/- per year. The government is going to avail the services of top fund managers from SBI, UTI, Kotak, ICICI etc to manage the corpus. Our money would be saved in Individual Retirement Accounts (IRAs) People who are sure of their risk appetite can choose the type of fund they want their money to be invested in. You can choose high equity exposure or high debt exposure based on your comfort level. For people who are not sure about this can opt for the default option. The default option works in life-stage principle. During the initial phases equity exposure would be high and after 35 years of age, it goes down and debt exposure would increase. This is to provide for capital appreciation when the investor is young and capital preservation as our age goes up.

After our retirement we can withdraw a portion of our IRA corpus as a lumpsum amount and the balance must be compulsorily be invested in annuities that give us a regular monthly income.

How would the NPS Work?

This scheme will have 3 intermediaries:

1. One to collect the contribution
2. One to manage the fund
3. One to take care of the disbursement

To ensure wide distribution, the PFRDA (Pension Fund Regulatory & Development Authority) has authorized 23 players comprising of banks, mutual funds etc through which we can invest in the NPS.

What are the costs involved with NPS?
Since the NPS is floated by the government and is targeted at the common man, the costs involved are not so high. The initial joining fees is Rs. 350/- and a registration fees of Rs. 40/- Once your account is created you will get a Permanent Retirement Account Number (PRAN)

The only incremental cost is the Rs. 20/- transaction fees that has to be paid every time we make a fresh contribution to our account. Apart from this, there is also a fund management fees. This is 0.0009% of our investment which works out to Rs. 9/- per every 10 lakh invested. In contrast a normal mutual fund house would charge us as high as Rs. 22,500/- and a ULIP would cost us even more.

Benefits of investing in NPS:

The NPS has a target audience of nearly 80 million Indians who are employed and are earning. There are a number of benefits in this scheme that would make it attractive for us

1. Simple – The scheme is very simple and easy to understand for the common man
2. Scalable – This scheme has the ability to handle any number of investors
3. Portable – Can be accessed from anywhere in the country
4. Flexible – It offers us varied investment options and also withdrawal facilities. We can make annual or half yearly or even quarterly payments into our IRA
5. Low Cost – This is one of the most important and significant benefits of this scheme. This is by far the cheapest investment option.


As in every investment option, when you have benefits, there would be negatives also. There are certain aspects that we need to consider before investing in the NPS

1. Not Mandatory – This scheme is not mandatory and hence the investment is purely based on individual interest. The purpose of this scheme is to provide retirement corpus for its citizens and since it is not mandatory, it may not serve its intended purpose effectively
2. Low awareness – Though this is a great option of investing for our retirement, the awareness among our public regarding this scheme is very low. Most of our population is not aware of this scheme
3. Low Tax incentives – There are no specific tax incentives available for us to motivate us to invest in this scheme
4. Too early to judge – This is a new scheme and we do not know the kind of returns that we can expect from this scheme. Also everything is theoretical and we are yet to see it functioning.

What should we do now?

This is a new scheme and the PFRDA is expected to pass bills and amendments and activate this scheme. The scheme will be launched on April 1st and nearly 80 million Indians including you and me are eligible to invest in this scheme.
The initial investment amount is very small and we can opt to invest in this scheme with a small amount and based on the kind of performance offered by the fund managers we can opt to increase our yearly investments.

Where can we buy?
As many as 23 institutions have been approved by the PFRDA as PoPs (Points of Presence) for the NPS. All citizens other than government employees covered under the pension scheme can buy NPS through the below centers.

1. Allahabad Bank
2. Axis Bank
3. Bajaj Alliance General Insurance Co.
4. Central Bank of India
5. Citibank
6. CAMS India Pvt Ltd
7. ICICI Bank
8. IDBI Bank
9. Kotak Mahindra Bank
10. LIC of India
11. Reliance Capital
12. State Bank of India
13. Union Bank of India
14. UTI Asset Management Company etc…

Happy Investing!!!
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