Wednesday, April 28, 2010

MF Dividends Disturbed

As many investors in mutual funds always do, we usually pick out mutual funds that have a track record of declaring healthy dividends every year and invest our hard earned money in them. The Stock Exchanges Board of India (SEBI) has come up with a new ruling that aims to disturb this trend which is likely to affect the amount of dividends declared my fund houses on their equity oriented schemes.

What the new rule says:

As per regulatory requirements the unit premium reserve (UPR) which is part of the sales price of units that is not attributable to realized gains and hence cannot be used to pay dividends.

Actually, this is not a new rule but rather has been part of the regulations for mutual fund houses for many years. Still, many MFs have used their UPR to declare dividends. This ruling from SEBI is aimed at curbing this practice.

Before we start discussing further we need to know what UPR is.

What is Unit Premium Reserve

When units of an open ended mutual fund are sold and the sale price is higher than the face value of the unit, part of the sale proceeds that represents unrealized gains are credited into a separate account which is called the Unit Premium Reserve.

Let us take an example:

Suppose A invested Rs. 10,000/- in a fund with NAV as Rs. 10/- he will get 1000 units. Assuming after a year the NAV goes up to Rs. 20/- and another investor B wants to invest Rs. 20,000/- he gets the same 1000 units which A has. Here Rs. 10/- is the unit capital and the remaining amount becomes a part of the unit premium reserve.

Let us say after another one year the MF house wants to declare a dividend when the NAV is at Rs. 30/- they will declare dividends based on the units held and not the amount invested which essentially means that for the person B who invested Rs. 20,000/- and bought 1000 units is going to get a dividend out of the money he invested rather than on the profit that was made out of his investment.

What this means to us (Investors)

The new regulation means that there will be no more hefty dividends on MFs. The dividends will have to be limited to the profits they make out of the investments and not from the UPR and hence they may not be as significant as the dividends declared out of the UPR.

In one line – Dividend Income is expected to come down significantly!!!

What does this rule intend on doing?

The rule intends on stopping/curbing two things:
1. Declaring dividends to investors from their own money (From the UPR)
2. Dividend Stripping.

Dividend Stripping
is a technique that is rampant in our stock markets because it is extremely legal and some investors use that to evade income tax on capital gains. Let me explain how…

Most MF houses unofficially inform investors about dividends before the actual dividend declaration date. Armed with this info, some investors invest money in the fund and pocked a tax free dividend and then exit the fund after a few days/weeks. Then they set off the losses from the investment against their other capital gains thereby reducing the tax liability on their capital gains.

With the new enforcement of the dividend rule, such investors may not be able to gain significant advantage because the dividends declared my fund houses is bound to go down.

Will Dividend funds become less attractive going forward?

The answer is “maybe” one of the main reasons people invest in dividend funds is the fact that, fund houses declare solid dividends every year. With the new ruling the dividend amount is sure to take a beating but still fund houses will declare decent dividends in order to retain their market edge. Hence I would keep myself invested in these funds and would not consider exiting just because they wont declare super dividends…

Happy Investing!!!

Tuesday, April 13, 2010

SEBI Lifts BAN on Insurance Cos to sell ULIPs

In a dramatic turn of events the stock market regulator SEBI has lifted the ban that it had imposed on Insurance cos this past friday on the sale of ULIPs.

The Story So Far:

January 2010 - SEBI issues show cause notice to insurance cos and IRDA asking why they haven't obtained approvals from them before flouting ULIP Plans

April 9th 2010 - With no satisfactory response from either IRDA or Insurance cos SEBI bans 14 companies from selling ULIPs

April 10th 2010 - IRDA rejects the Ban and advises insurance cos to carry out business as usual

April 12th 2010 - Finance Ministry expected to intervene to sort things out

To read the whole story Click Here

Latest Developments:

The Finance Minister Mr. Pranab Mukherjee had a discussion with members from both SEBI and IRDA and the group had come to a consensus reg. the issue and this resulted in SEBI lifting the ban on the insurance cos.

Is this good news:

Definitely it is good news for all investors who have put in their hard earned money. Approximately 10 lakh crores of indian rupees is said to be the asset under management in the ULIPs of the 14 companies that were banned and any negative decision from SEBI would have had adverse effects on all investors.

Finally some relief for us :)

Monday, April 12, 2010

Income Tax in India

Every individual who earns an income in India is supposed to pay Tax on the Income earned by him during that financial year to the government of India. Calculation of the Income Tax to be paid by an individual is a cumbersome process. The government of India provides certain benefits to its citizens who earn an income in the country by means of deductions, exemptions etc. Before going into the details below are the items that would be covered in this article.

1. Heads of Income
a. What exactly qualifies to be an income, for which you need to pay Tax.
b. Salary Perquisites that are taxable
2. Deductions
a. House Rent Allowance – HRA
b. Leave Travel Allowance – LTA
c. Medical Allowance
d. Transportation Allowance
e. Interest paid on Housing Loan
3. Exemptions
a. Under Section 80C
b. Under Section 80D
c. Under Section 80DD
d. Under Section 80DDB
e. Under Section 80E
f. Under Section 80U

4. Clubbing of Minor Income

Heads of Income:
The Heads of Income includes the types of income earned by an individual that would qualify as Income for which he/she needs to pay tax. These include the components that would be earned by an individual through employment with an organization/company. They are:
1. Salaries & Wages
2. Bonus & Commissions
3. Other Perquisite benefits

According to the IT laws Perquisites include the following:
a. Rent free accommodation or concessional rate accommodation received from the employer
b. Any other benefit given by the employer either in cash or material (Apart from monthly Salary)
c. Any Fringe benefits provided by the employer (This would include Mobile bill reimbursement, Petrol expenses etc)

Deductions on Income:

As per the IT regulations, there are certain deductions that are allowed on the income earned by an individual. These amounts can be subtracted while arriving upon the net taxable salary of an individual.

They include:
1. Housing Rent Allowance (HRA)
The HRA is usually a part of the salary/wages paid out to an employee by the employer. The deduction on HRA is eligible to any individual who is residing in a rented house and is paying rent to the house owner. There are some rules that govern the limit till which HRA can be deducted from your taxable income. Out of the below mentioned 3 items whichever is LEAST will be considered for the purpose of deduction under the HRA component.
a. Actual amount of the HRA paid by the employer (As part of Salary) Or
b. 50% of Basic salary in case of Metros (Delhi, Bombay, Calcutta & Chennai) or 40% of Basic salary in case of non Metros. Or
c. Actual rent paid by the individual – 10% of Basic salary
For e.g., your monthly Basic salary is Rs. 12,000/- and the HRA component as per your salary is Rs. 6000/- and the actual rent you are paying is Rs. 6000/- in Chennai then the amount you would be eligible for HRA exemption is Rs. 4800/- (Actual rent – 10% of Basic salary) per month.

2. Leave Travel Allowance (LTA)
LTA also is usually a part of the salary paid out to an employee as part of his employment. As per the Indian tax laws you are eligible to claim an amount that less than or equal to the total LTA paid out to him by his employer. This would cover the expenses incurred in travel of self with/without dependents. (Dependents would include spouse, children and dependent parents) There are some conditions which need to be satisfied for an individual to claim exemption under LTA. They are:
a. LTA can be claimed only twice in a block of 4 financial years. You cannot claim LTA every year.
b. Only Transportation expenses would be considered for LTA. Accommodation & food expenses are not considered.
c. For an employee to be eligible for claiming LTA, he/she should have taken at least 3 days of earned leave from the employer

3. Medical Allowance
Medical allowance is also a part of the salary paid out to an employee. The maximum amount eligible for this component is either Rs. 15,000/- or the actual amount paid out to you as part of Salary. To claim exemption under this you need to provide medical bills to substantiate your claim of having incurred medical expenditure. The medical bills can be in the name of the individual or his spouse or children or dependent parents.

4. Transportation Allowance
The IT laws permit a deduction of Rs. 9,800/- as a standard transportation allowance to all resident individuals who pay income Tax. This amount is standard irrespective of the job/industry the individual is employed. Also this amount does not change irrespective of the means of transport you use to commute to your office.

5. Interest Paid on housing loan
The IT laws permit an individual who has taken a home loan from a recognized bank for the purpose of construction or purchase of a residential property to claim exemption on tax on the interest part of the loan taken by the individual. There is a limit to this exemption which is as follows.
a. If the property is occupied by the individual then the maximum eligible amount under this is Rs. 1,00,000/-
b. If the property is rented out and the rental income is included in the total income earned by the individual then there is no maximum amount. The actual interest paid on the home loan can be used for deduction from total salary considered for the purpose of income tax.
Note: Exemption is available on home loans taken to purchase residential property only. Home loans taken to purchase land do not qualify for income tax exemption.

Income Tax Exemption:

The Income Tax laws allow all individuals who are assessed for income tax to claim exemption from income tax under the following heads.
1. Section 80C

The section 80C of the IT laws provide exemption from income tax on amounts that are invested by the individual. This usually includes the amount the individual invests in certified instruments that are exempt from tax. They are:
a. PF – Provident Fund (A portion of your salary is deducted by your employer as PF and would be remitted to the PF house that is maintained by the government of India. A maximum of 12% of your basic Salary is eligible for exemption from income tax)
b. PPF – Public Provident Fund – A maximum of Rs. 70,000/- per financial year.
c. ELSS – Equity Linked Savings Scheme (Mutual funds)
d. NSC – National Savings Certificate
e. KVP – Kisan Vikas Patra
f. Life Insurance (Insurance provided by LIC & Other registered Insurance companies)
g. Tax Saving ULIP’s – Unit Linked Insurance Plans
h. Principal amount repaid as part of the Home loan
i. 5 year bank fixed deposits
A point to be noted here is that the sum total of all these components can be a maximum of Rs. 1,00,000/- per financial year.

2. Section 80D

This section of the IT laws provide exemption on the premium paid towards Medical insurance of the individual, spouse & children and also dependent parents. The maximum eligible amount under this section is Rs. 15,000/- per financial year.

3. Section 80DD

Exemption under sec 80DD is available to any individual who:
a. Incurs any expenditure for the medical treatment, training and rehabilitation of a disabled dependent Or
b. Deposits any amount in schemes of the LIC of India for the maintenance of the disabled dependent.
A deduction of Rs. 50,000/- is available to all individuals who incur any of the above two said expenditures. Where the dependent has a Severe disability a deduction of Rs. 1,00,000/- is allowed. An individual should furnish a copy of the issued certificate by the medical board constituted either by the Central government or a state government in the prescribed form, along with the return of income of the year for which the deduction is claimed.

4. Section 80DDB
An individual, resident in India spending any amount for the medical treatment of specified diseases affecting him or his spouse, children, parents, brothers and sisters and who are dependent on him, will be eligible for a deduction of the amount actually spent or Rs 40,000, whichever is less.

For any amount spent on the treatment of a dependent senior citizen an individual is eligible for a deduction of the amount spent or Rs 60,000, whichever is less is available. The individual should furnish a certificate in Form 10-I with the return of income issued by a specialist working in a government hospital.

5. Section 80E
Under this section, deduction is available for payment of interest on a loan taken for higher education from any financial institution or an approved charitable institution. The loan should be taken for either pursuing a full-time graduate or post-graduate course in engineering, medicine or management, or a post-graduate course in applied science or pure science. There is no upper limit and the entire interest amount repaid each year to the bank for a period of 8 years is exempt from income tax

6. Section 80U - It is deduction in the case of a person with a disability. An individual who is suffering from a permanent disability or mental retardation as specified in the persons with disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995 or the National Trust for Welfare of Persons with Autism, Cerebral Palsy, Mental Retardation and Multiple Disabilities Act, 1999, shall be allowed a deduction of Rs 50,000. In case of severe disability it is Rs. 75,000.

The Income tax assessee should furnish a certificate from a medical board constituted by either the Central or the State Government, along with the return of income for the year for which the deduction is claimed.
Note: Section 80U is available only for individuals who are disabled but still earn an income that qualifies for income tax.

Clubbing of Minor Income:
There might be cases where the minor child in the family earns an income that could be through interest earned on deposits in the name of the minor or through dividends on shares held in the name of the minor etc. Under such a situation,
• The minor's income is clubbed with that of the parent with the higher income.
• Only income earned till the year the minor attains age 18 is clubbed.
In excess of Rs. 1,500 earned by a minor, the income is added to the parent with higher income, irrespective of the residential status of either the child or the parent. The clubbing provision is applicable even if the parents are NRI and the minor stays in India or vice-versa.

To know about the Tax Slabs for the financial year 2010 - 2011 Click Here

SEBI Bans Major Insurance Companies from conducting ULIP business

Many of us today have invested in ULIP plans with some top Insurance cum Asset Management Companies in India. These ULIPs span from retirement plans to children’s education and covering almost every aspect of investment for an investor. Last week, SEBI – the governing body for stock market investments had banned 14 of the top insurance companies in India from conducting business in ULIPs without its approval. We are going to dig deep as to what happened and how it would impact us…

SEBI vs IRDA face off

The Securities Exchange Board of India and the Insurance Regulatory and Development Authority have been mulling over the ULIP story for quite some time. There has been discussions between these two boards reg. regulation of ULIPs. It all started in January 2010 when SEBI issued a show cause notice to insurance companies asking them to explain why they did not seek the approval from SEBI before launching ULIP plans. The ULIP business has been flourishing in the Jan to March quarter because it is the financial year end and investors were scrambling to save income tax by investing in tax saving instruments.

With discussions going on between SEBI and IRDA and with no satisfactory response from IRDA and the insurance company, SEBI went ahead and banned 14 of the top fund management and insurance companies in India from conducting further business with these ULIPs

Why Ban ULIPs?

SEBI is the governing body for all stock market related investments and hence has the power to oversee any instrument that invests in the stock market. These ULIPs are special investment instruments that gives exposure to the stock market and gives insurance to the investor and hence many insurance companies have flouted ULIPs of their own. Since insurance companies are issuing these, the IRDA has been regulating them ever since their inception.

In January 2010 SEBI issued show cause notice to the insurance companies to explain why they did not seek SEBIs approval before launching these schemes and to get their approval for the same to continue with the ULIP business.

Insurance regulator IRDA is understood to have stated in its reply that regulation of ULIPS by IRDA is well-laid down and that it does not agree with Sebi contention that insurers need a certificate of registration from the market regulator for dealing in ULIPS.

Since ULIPs are issued by insurance companies, SEBI does not have full control over these instruments and hence wanted to regulate the ULIP segment and as it could not get satisfactory responses from IRDA it went ahead and Banned these insurance companies from doing business with ULIPs until cleared by them.

What are these 14 companies?

The 14 insurance companies are:-
  • n Religare Life Insurance Company Limited
  • Aviva Life Insurance Company India Limited
  • Bajaj Allianz Life Insurance Company Limited
  • Bharti AXA Life Insurance Company Limited
  • Birla Sun Life Insurance Company Limited
  • HDFC Standard Life Insurance Company Limited
  • ICICI Prudential Life Insurance Company Limited
  • ING Vyasa Life Insurance Company Limited
  • Kotak Mahindra Old Mutual Life Insurance Limited
  • Max New York Life Insurance Co. Limited
  • Metlife India Insurance Company Limited
  • Reliance Life Insurance Company Limited
  • SBI Life Insurance Company Limited
  • TATA AIG Life Insurance Company Limited
IRDAs reaction to the Ban

The IRDA rejected the market regulator Sebi's ban on life insurance companies to raise funds through unit-linked insurance policies (ULIPs) and asked them to do business as usual.

Where is this heading?

It is a tussle between the regulator for stock market investments and the regulator for insurance in India and it will go on for quite some time. In my personal opinion insurance companies are bound to be regulated by the SEBI because they are investing in the stock markets but at the same time SEBI cannot intervene in the business of Insurance cos as long as they abide by the investment laws of our nation.

What is the impact on us as an investor?

With this tussle between IRDA and SEBI expected to go on for some time, authorities from IRDA have come up with news statements to allay the fears of the investors. A simple question that would arise in any investors mind is:

“If ULIPs are banned by SEBI what will happen to my hard earned money that I have invested in it, especially after the huge crash in NAVs after the stock market crisis in the past two years”

J Hari Narayan, chairman of IRDA, has told reporters that, "Policyholders of the ULIPs offered by different insurance companies are assured that these policies are safe and secure and the matters arising out of the recent orders of the SEBI will be addressed expeditiously in the appropriate forum in accordance with Law."

Though, the chairman of IRDA has come up with a comforting press release, things are hardly settled. The regulator (SEBI) has been staying away from these ULIP plans for the past few years and out of the blue it has entered the fray and banned them because of lack of approval. A full fledged face off between IRDA and SEBI can be expected in the courts of Law in India.

What is the Finance Ministry's stand in this matter?

As of now the finance ministry is keeping a safe distance from this problem. But, it is rumoured that the Finance Minister would be briefed about the matter and we can expect a full stop to this struggle between IRDA and SEBI.

The Finance Secretary Mr. Ashok Chawla has told reporters that "It's a matter between regulators; so they have to decide"

What Next?

Industry Experts across the country are hoping for the finance ministry to enter the picture and clear the air and settle things down between the two regulatory bodies in a way that investor interests are not compromised.

Let us wait and watch!!!

Different Categories of Investors for an IPO

We already know what an IPO is and the Various Intermediaries in an IPO Process. Let us now take a look at the different category of investors who can invest in IPO’s

As far as an IPO is concerned, the total shares issued to the public are divided into 3 major parts for 3 different category of investors. They are:

1. Qualified Institutional Buyers
2. Non Institutional Investors
3. Retail Investors

Qualified Institutional Buyers (QIB)

Under this quota, financial institutions such as banks, mutual funds, insurance companies, Foreign Institutional Investors (FIIs) etc are permitted to bid for shares. A maximum of 50% of the issue can be reserved for investors falling under the QIB category. Out of this 50% a 5% can be reserved for Mutual Funds

Non Institutional Investors

Under this Quota, resident Indian Individuals, Hindu Undivided Families (HUF), companies, NRIs, Societies and trusts whose shares application bid is more than Rs. 1 lakh are allowed. At least 15% of the total issue can be reserved for this group. This is also called as the High Net worth Individual (HNI) quota

Retail Investors

Under this quota, only individuals both residents and NRIs along with HUFs are allowed to bid. The application size here should be less than Rs. 1 lakh. A minimum of 35% of the issue has to be reserved for such people.

When shares are issued in an IPO – we usually hear the term oversubscribed. This term is applicable for each of these categories separately. The Retail bucket could be oversubscribed 5 times whereas the HNI bucket could be oversubscribed 10 times and QIBs 4 times.

What is meant by oversubscribed?

An IPO is considered to be oversubscribed when there are more people willing to buy shares than the total number of shares that are available.

Let us say a company comes up with an IPO that offers 10 lakh shares to Retail Investors and 50,000 investors apply for 100 shares each - the total requirement here is 50 lakh shares whereas there are only 10 lakh shares available. Hence the issue is said to be oversubscribed by 5 times in the Retail Investor segment.

IPO - Different Types of Issues

In one of my previous articles we had seen about the various intermediaries who are involved in an IPO process. In this article let us take a look at the different types of issues that a promoter can do in order to raise capital for his business. They are:
1. Initial Public Offer
2. Offer for Sale
3. Follow on Offer
4. Rights Issue
5. Preferential Issue

Initial Public Offer (IPO)

When an unlisted company (A company that does not already have shares in the stock market) invites the public to buy its fresh issue of shares, which will then be listed on a stock exchange like NSE or BSE, the issue is called an IPO

Offer for Sale

When existing shareholders of an unlisted company invite the public to buy their shares which will then be listed on the stock exchange is called an Offer for Sale

Follow on Public Offer (FPO)

When an already listed company makes either a fresh issue of shares to the public or an offer for sale of existing shares to the public, it is referred to as a follow on public offer

Rights Issue

When a listed company proposes to issue fresh shares to its existing shareholders, it is called as a rights issue. Rights shares are normally offered to existing investors in a particular ratio corresponding to the number of shares they already hold with the company. For Example if a company issues a 1:2 rights issue @ Rs. 20/- per share, every investor who holds 2 shares of the company already can buy 1 new share at Rs. 20/- per share. This route is best suited for companies who would like to raise capital without diluting the % stake of existing shareholders.

Preferential Issue

A Preferential issue is when a listed company decides to issue shares to a select group of persons who are not current share holders of the company. This type of an issue will dilute the % holding of current shareholders and will require their permission. These issues are normally done when a company desires to issue a block of shares to a select/particular group of people. The issuing company has to comply with the provisions of the Companies Act and also all SEBI guidelines apart from getting approval from existing shareholders to go ahead with the issue.

Sunday, April 11, 2010

Intermediaries involved in an IPO Process

In one of my earlier articles about Equity Shares – I had explained about how an IPO process happens. Let us dig deeper into an IPO process and discuss on the details.
An IPO stands for Initial Public Offering – the first time a company offers shares to the various sections of the investor population in our country. In the primary market when a share is issued/offered to public, the money that we pay towards the share goes directly to the promoters of the company.

To Refresh – An IPO is a process where the promoters of a company issue shares to the public to raise money to expand and run their business more effectively. Once an IPO is complete, the shares are delivered to the public and the promoters can use the money for their business. Once every year the company would declare its results and maybe a Dividend to keep its share holders happy. When an IPO is offered it can be either at face value or at a premium.

Issue at Face Value:
This is an issue where the promoters of the company issue shares to the public at the face or base value of the share. The face value of shares is usually Rs. 10 or Rs. 5 or Rs. 1 or any other denomination that the promoters deem appropriate. Such issues are very rare.

Assuming the company issues 100,000,000 shares @ Rs. 5 per share face value the company would make Rs. 500,000,000/-

Issue at a Premium:
This is an issue where the promoters of the company issue shares to the public at a price which is much higher than its face value. The value that an investor pays for a share over and above its face value is termed as the “Premium”

Assuming the company issues 100,000,000 shares of Rs. 5 face value @ Rs. 50 per share, the company would make Rs. 5,000,000,000/-

Here an investor is willing to pay Rs. 45/- extra per share over and above the original price of Rs. 5/- per share because of the history of profit making and strong business presence over the previous years. Since the investor feels that this company can continue to exhibit such strong business performance he is willing to offer this Premium.

Now that we know the basics of what an IPO is let us see the various intermediaries in a public issue.

When a company launches an IPO inviting the public to buy its shares, it has to appoint various intermediate people who will enable them t successfully complete the issue process. They are:

1. Book Running Lead Managers (BRLMs)
2. Bankers for the Issue
3. Underwriters
4. Registrars etc...

Book Running Lead Managers:

The company issuing shares appoints the BRLM or the Lead Merchant Bankers. The role of the BRLM can be divided into two parts, viz., Pre Issue and Post Issue.
The Pre Issue role includes compliance with the stipulated requirements of SEBI and other regulatory authorities, completion of formalities for listing of the shares on the Stock Exchanges (NSE or BSE in India) appointing of various agencies like advertising agencies, printers, underwriters, registrars, bankers etc.
The Post Issue activities include management of escrow accounts (The bank accounts where the money from all share applicants will get deposited), deciding the final share issue price, share allotment to applicants, ensuring proper refund to unsuccessful applicants, allotment letters and ensuring that each agency is carrying out their requisite functions properly and by abiding by the laws laid down by SEBI for an IPO process.

Bankers to the Issue:
Bankers to the issue, as the name suggests are the people who carry out all banking activities like accepting the money from the applicants, transfer of funds to the promoters and transfer of refunds to unsuccessful applicants.

The Registrar finalizes the total list of all applicants and comes up with the list of eligible applicants after deleting all invalid applications. Then he ensures that shares are credited to the allottees accounts and refunds are sent to unsuccessful applicants.

Underwriters to the Issue:

Underwriters are the institutions/individuals who agree to buy the shares of the company in case the company is unable to sell all its shares to the public. For providing this safety, the underwriters charge a commission to the company for providing this service.

Happy Investing!!!

Friday, April 9, 2010

Good News for Savings Account Holders

We all hold savings bank accounts with different banks in India and we also know that the rate of interest that we earn on this money is a pathetic 3.5% per annum. This is very low considering the fact that our nations inflation is hovering around the 10% mark. There is some good news for all savings account holders because with effect from April 1st 2010, there is a small change in the way the interest accrued on our bank account is calculated.

Earlier Method: The minimum balance maintained in the account between the 10th and the last day of the month (say 30th or 31st) will be taken for the interest computation

New Method: The balance at the end of every day will be taken into account for interest computation.

Let us check this with a real time example:

Mr. X get his salary of Rs. 50,000/- on the 1st – Balance in Account Rs. 50,000/-
Withdraws Rs. 20,000/- for family expenditure on 8th – Balance in Acc Rs. 30,000/-
EMI on Personal loan Rs. 15,000/- deducted on 15th – Balance in Acc Rs. 15,000/-
Withdrawal of Rs. 10,000/- to meet sudden expenses on 25th – Balance in Acc Rs. 5,000/-

Now let us compute the Interest earned in the account by both ways.

As per the Earlier Method:

Amount considered for interest computation = Rs. 5,000/-

Interest earned for the month = Rs. 14.58/-

As per the New Method:

Balance considered for Interest for 7 days = Rs. 50,000/-
Balance considered for Interest for the next 7 days = Rs. 30,000/-
Balance considered for Interest for the next 10 days = Rs. 15,000/-
Balance considered for the last 6 days = Rs. 5,000/-

Total No. of days in the month = 30 days

Interest for first 7 days (Rs. 50,000/-) = Rs. 34.02/-
Interest for next 7 days (Rs. 30,000/-) = Rs. 20.41/-
Interest for next 10 days (Rs. 15,000/-) = Rs. 14.58/-
Interest for the last 6 days (Rs. 5,000/-) = Rs. 2.92/-

Total Interest Earned for the month = Rs. 71.93/-

This is nearly 5 times as that of the interest earned by the old method.

What is the Impact on us?

1. People who need cash for short term liquidity can retain the money in their bank accounts instead of transferring them to short term Fixed Deposits like 30 or 60 days because the interest on your savings account will be atleast as much as the FD and most importantly it is much more liquid and there are no penalties on withdrawal
2. People who had maintained a solid balance till the 25th or 26th of the month and had to withdraw money for some urgent reason need not lose out on the interest for those 25 or 26 days. Every ten thousand rupees in your savings account earns an interest of one rupee for every day that it is kept in your account.

Happy Investing!!!!!

Changes in Income Tax Laws for the financial year 2010 – 2011

The Financial Budget for the forthcoming/current financial year 2010 – 2011 is considered a great boon for all of us (Salaried class) The Finance Minister has come up with a lot of new changes in the taxation policies that will leave a lot of extra cash in the pockets of the salaried class even if they are going to get the same salary that they got in the previous financial year 2009 – 2010. Let us see the salient points that may affect our take home salary in this year.

1. Increase in Base exemption (Standard Deduction)
2. Change in Tax Slabs (% Changes)
3. Removal of 10% surcharge on Income Tax
4. Increase in 80DD section
5. Fringe Benefit Tax (FBT) is abolished

Let us take a detailed look at each one of these items.

Increase in Base Exemption Amount – Standard Deduction:

The Standard Deduction or the base portion of a tax payers salary that is exempt from tax has been increased by Rs. 10,000/- for all and by Rs. 15,000/- for senior citizens.

So the current Non Taxable Income is as follows:

Male Citizen – Rs. 1,60,000/-
Female Citizen – Rs. 1,90,000/-
Senior Citizen – Rs. 2,40,000/-

Change in Tax Slabs

One of the major contributors to additional take home salary for the salaried class is the change in the taxation slabs. The Finance Minister has significantly increased the tax slabs for the 10% and 20% slabs and hence people who were in the highest tax paying bracket in the previous financial year (09-10) would come down to probably the 20% slab this year. Below is the Revised slabs.

Male Citizen:

Salary Range Income Tax %
Upto Rs. 1,60,000 Nil (No Tax)
1,60,001 to 5,00,000 10%
5,00,001 to 8,00,000 20%
Above 8,00,000 30%

Female Citizen:

Salary Range Income Tax %
Upto Rs. 1,90,000 Nil (No Tax)
1,90,001 to 5,00,000 10%
5,00,001 to 8,00,000 20%
Above 8,00,000 30%

Senior Citizen:

Salary Range Income Tax %
Upto Rs. 2,40,000 Nil (No Tax)
2,40,001 to 5,00,000 10%
5,00,001 to 8,00,000 20%
Above 8,00,000 30%

Removal of Surcharge on Income Tax:

Until the previous financial year there was an extra 10% surcharge on the income tax amounts for people with salaries above Rs. 10 lacs which has been completely removed

Increase in Section 80DD deduction:

As per the prevailing IT laws a tax payer who has a physically handicapped dependent, he can claim the medical expenditure for the dependent as tax exempt income. This limit has been hiked from Rs. 75,000/- per year to Rs. 1,00,000/- per year

Fringe Benefit Tax Abolished:

The Fringe Benefit Tax that resulted in extra taxes for employees in certain lines of work for claiming expenditure they incurred while on work has been completely abolished.

Impact on US – The Tax Payers:

The benefits for us the citizens in the salaried class is significant. Let us take a simple Example of Mr. X who earns Rs. 10,00,000/- annual income and calculate the taxes for the two financial years.

Assumptions: Exemptions under Section 80C – 1 lakh
He claims exemptions under section 80DD to the full extent
HRA @ Rs. 1,00,000/- per year
Medical Expenses @ Rs. 15,000/- per year
Transportation Expenses @ Rs. 9,800/- per year

As per Tax Slabs 2009 – 2010:

Total Salary = Rs. 10,00,000/-
Less Section 80 C = Rs. 9,00,000/-
Less HRA, Medical & Transport = Rs. 7,75,200/-
Less Section 80DD = Rs. 7,00,200/-

Net Taxable Salary = 7,00,200/-

Income Tax:
Upto Rs. 1.5 lacs = Rs. 0/-
Rs. 1.5 to 3 lacs (@ 10%) = Rs. 15,000/-
Rs. 3 to 5 lacs (@20%) = Rs. 40,000/-
Above 5 lacs (@30%) = Rs. 60,060/-

Net Income Tax: 1,15,060/-

Approximate Tax Deducted @ Source (TDS) per month = Rs. 9588/-

As per Tax Slabs 2010 – 2011:

Total Salary = Rs. 10,00,000/-
Less Section 80 C = Rs. 9,00,000/-
Less HRA, Medical & Transport = Rs. 7,75,200/-
Less Section 80DD = Rs. 6,75,200/-

Net Taxable Salary = 6,75,200/-

Income Tax:
Upto Rs. 1.6 lacs = Rs. 0/-
Rs. 1.6 to 5 lacs (@10%) = Rs. 34,000/-
Rs. 5 to 8 lacs (@20%) = Rs. 35,040/-

Net Income Tax: Rs. 69040/-
Approximate Tax Deducted @ Source (TDS) per month = Rs. 5753/-

Increase in Take Home Salary per month = Rs. 3835/-

Isn’t this a sizeable hike in take home salary given the fact that there is no hike in the annual income? It definitely is.

All the best!!!

Monday, April 5, 2010

Difference between Risk Tolerance and Risk Taking Capacity

These two terms Risk Tolerance and Risk Taking Capacity are commonly encountered in any article that talks about investment or financial planning. Many people usually confuse these two terms and hence I thought it would be a nice idea to clarify on it.

Before we go on we need to know "What is RISK?"

Risk on an investment instrument is the chance that your investment would go down in value, i.e., you lose money.

Ex: You buy 1000 shares of ABC Ltd. today @ Rs. 100/- per share by investing Rs. 1 lac and after 10 days due to a bad news about the company the price per share goes down to Rs. 10/- per share (Ex: Satyam Computers SCAM) Your total net investment's worth is only Rs. 10,000/-

Such an unexpected event is termed as a Risk on the investment.

What is Risk Taking Capacity:

Risk Taking Capacity is termed as the capacity an individual investor has in terms of taking risk with his investments. He/She has a higher chance of managing his finances even in such an unfortunate event. A young man in his mid 20's and earning well can manage such a stock price tumble but his elder brother in his early 30's with a wife and a child cannot handle this because he has a family depending on him.

This is called the Risk Taking Capacity.

You might already know that there are many classes of investments with equities and debt being the two most common ones. As a rule of the thumb the % exposure to debt instruments should be your current age and % exposure to equities should be 100 - your current age.


Ajay is 25 years old. So his asset allocation should be

Equities - 75%
Debt - 25%

Ajay's elder brother Vijay is 35 years old. So his asset allocation should be

Equities - 65%
Debt - 35%

As you can see above, as your age goes up your exposure to equities comes down and the exposure to debt goes up.

Risk Taking Capacity is the amount of RISK you SHOULD take on your investments considering various factors. These various factors include:

1. Your Age
2. No. of Dependents (Old Parents, Wife, Children)
3. Security of your current job

Based on the various parameters that suit you, your allocation towards debt must go up and equities must come down.

Risk Tolerance:

This is another term that is commonly used. This simply refers to the amount of losses you can tolerate. For Ex: Ajay being a youngster is very enthusiastic and the moment he makes some losses in the stock market, he spends sleepless nights, withdraws his investments even if it means suffering losses etc whereas his elder brother Vijay has already lived through those stages and hence doesn't sweat much in case of such mishaps and tries to make the best of the given situation.

Here Ajay's Risk Tolerance is LOW whereas Vijay's Tolerance is HIGH

It is simply a matter of the mindset and its capability to handle losses.

You and me need not be exactly in either Ajay or Vijay's situation but we could be a combination of both.

Make sure you check your Risk Taking Capacity and Risk Tolerance before deciding on your investment instrument.

Happy Investing!!!!!

Sunday, April 4, 2010

Common Financial Terms - Part VI

Synthetic Put

A transaction involving the purchase of a call option on a stock that has already been shorted. This enables the holder to protect against an increase in the price of the underlying stock. If the stock price decreases, the call is not exercised and the investor profits minus the premium. If the stock price increases, the call is exercised and the investor breaks even minus the premium and short interest.

Global Depositary Receipt

A negotiable certificate held in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country. American Depositary Receipts make it easier for individuals to invest in foreign companies, due to the widespread availability of price information, lower transaction costs, and timely dividend distributions. also called European Depositary Receipt.

Knock-out Option

An option that becomes worthless in the event that the underlying commodity or currency crosses a certain price level.

Capital Net Worth

Total assets minus total liabilities of an individual or company. For a public company, the excess of assets over liabilities consist of retained earnings, common stock and additional paid-in surplus; here also called owner's equity or shareholders' equity or net assets. For an individual, the excess of assets over liabilities is most likely to come from savings and any additional contributions to income that they have received. Some economists say net worth is not very useful, since financial statements value most assets and liabilities at historical cost, which is usually not a good indicator of true value. also called capital net worth.

Married Filing Separately

A tax filing status indicating that a married couple is filing two separate tax returns, one for each individual. Married couples have the option of filing jointly or separately. Although filing jointly often results in less taxes, filing separately is sometimes preferable when one partner has significant medical expenses, casualty losses, or miscellaneous itemized deductions.

Forward Outright Rate

The forward rate of a foreign exchange contract, often expressed as U.S. dollars per foreign currency.

Contract For Difference

CFD. A contract between two people that mirrors the situation of trading a security, without actually buying or selling the security. The two parties make a contract that the seller will pay the buyer the difference in price after a certain period of time if the designated security's price increases, and the buyer will in return pay the seller the difference in price if the security's price decreases. CFDs are traded in over the counter markets in many countries, although they are not allowed in the United States.


Slang term for the U.S. ten dollar paper currency. The slang is derived from the Roman numeral for ten, "X". The "X" looks like the shape of a sawbuck, a device used to hold wood in place for sawing it into pieces.


The 7-member Board of Governors that oversees Federal Reserve Banks, establishes monetary policy (interest rates, credit, etc.), and monitors the economic health of the country. Its members are appointed by the President subject to Senate confirmation, and serve 14-year terms. also called the Federal Reserve Board.

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