Friday, April 10, 2009

Fixed Income Products

 
What are Fixed Income Instruments?

Fixed income refers to any type of investment that yields a regular (fixed) payment. For example, if you borrow money and have to pay interest once a month, you have been issued a fixed income security. When a company does this, it is often called a bond or corporate bank debt.

Fixed income securities can be contrasted with variable return securities such as stocks. To understand the difference between stocks and bonds, you have to understand a company's motivation. A company wants to raise money, and it doesn't want to wait until it has earned enough through ongoing operations (selling products or providing services). In order for a company to grow as a business, it often must raise money; to finance an acquisition, buy equipment or land or invest in new product development. Investors will only give money to the company if they believe that they will be given something in return commensurate with the risk profile of the company. The company can either pledge a part of itself, by giving equity in the company (stock), or the company can give a promise to pay regular interest and repay principal on the loan i.e. bonds, bank loans, fixed deposits etc.

While a bond is simply a promise to pay interest on borrowed money, there is some important terminology used by the fixed income industry:

  • The principal of a bond is the amount that is being lent.
  • The coupon is the interest that will be paid.
  • The maturity is the end of the bond, the date that the amount must be returned.
  • The issuer is the entity (company or govt.) who is borrowing the money (issuing the bond) and paying the interest (the coupon).
  • The indenture is the contract that states all of the terms of the bond.
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Types of Fixed Income Securities with Examples
1.An Investor must note that with higher return on a Fixed Income Security is attached a higher risk of default. Following are some of the Fixed Income Securities available in India:
Manufacturing Companies Fixed Deposit Schemes
Example

An investor can deposit funds with Omaxe Constructions Ltd. for a period of 6 Months, 12 Months, 24 Months and 36 Months and get a return of 8.5%, 9.0%, 10% and 10.5%, respectively.

  6 Months 12 Months 24 Months 36 Months
Omaxe Constructions Ltd. 8.50% 9.00% 10.00% 10.50%
2.Government Companies Fixed Deposits Schemes
Example
An investor can deposit funds with Kerala Transport Dev. Fin. For a period of 12 months, 24 months, 36 months, 48 months and 60 months and get a return of 6.75%, 7%, 7.25%, 7.75% and 8%, respectively.
  12 Months 24 Months 36 Months 48 Months 60 Months
Kerala Transport Dev. Fin. 6.75% 7.00% 7.25% 7.75% 8.00 %
3.Non-Banking Finance Company's (NBFC)'s Schemes
Example
An investor can deposit funds with First Leasing for a period of 12 months, 24 months, 36 months, 48 months and 60 months and get a return of 6.5%, 7.50%, 8.00%, 8.00% and 8.00%, respectively.
  12 Months 24 Months 36 Months 48 Months 60 Months
First Leasing 6.50% 7.50 % 8.00% 8.00% 8.00 %
4.Housing Finance Companies Fixed Deposits Schemes
Example
An investor can deposit funds with Birla Home Finance Ltd. for a period of 12 months, 24 months, 36 months, 48 months and 60 months and get a return of 6.25%, 6.25%, 6.5%, 6.75% and 7%, respectively.
  12 Months 24 Months 36 Months 48 Months 60 Months
Birla Home Finance Ltd. 6.25 % 6.25 % 6.50% 6.75% 7.00%
5.Post Office Monthly Income Schemes
Example
The post-office monthly income scheme (MIS) provides for monthly payment of interest income to investors. It is meant for investors who want to invest a sum amount initially and earn interest on a monthly basis for their livelihood. The MIS is not suitable for an increase in your investment. It is meant to provide a source of regular income on a long term basis. The scheme is, therefore, more beneficial for retired persons.
Features
Only one deposit is available in an account. Only individuals can open the account; either single or joint.( two or three). Interest rounded off to nearest rupee i.e, 50 paise and above will be rounded off to next rupee. The minimum investment in a Post-Office MIS is Rs 1,000 for both single and joint accounts. The maximum investment for a single account is Rs 3 lakh and Rs 6 lakh for a joint account. The duration of MIS is six years.
Returns
The post-office MIS gives a return of 8% on maturity. The minimum investment in a Post-Office MIS is Rs 1,000 for both single and joint accounts
Advantages
Premature closure of the account is permitted any time after the expiry of a period of one year of opening the account. Deduction of an amount equal to 5 per cent of the deposit is to be made when the account is prematurely closed. Investors can withdraw money before three years, but a discount of 5%. Closing of account after three years will not have any deductions. Monthly interest can be automatically credited to savings account provided both the accounts standing at the same post office. The interest income accruing from a post-office MIS is exempt from tax under Section 80L of the Income Tax Act, 1961. Moreover, no TDS is deductible on the interest income. The balance is exempt from Wealth Tax.
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How to choose a good company deposit scheme?
Here is a simple checklist to help you to choose the best company for investment.
  • Ignore the unrated Company Deposit Schemes. Ignore deposit schemes of little known manufacturing companies. For NBFC's, RBI has made it mandatory to have an 'A' rating to be eligible to accept public deposits, one should go further and look at only AA or AAA schemes.
  • Within a given rating grade, choose the company with a better reputation..
  • Once you decide on a company, next choose the schemes that have given a better return. Unless you need income regularly, you should prefer cumulative to regular income option since the interest earned automatically gets reinvested at the same coupon rate giving upon better yields. It also gives you a lump-sum amount at one go.
  • It is better to make shorter deposit of around 1 year or less. This way you not only can keep a watch on the company's rating and servicing but can also plan to have your money back in case of emergency.
  • Check on the servicing standards of the company. You should not oblige companies that care little about investor services like promptly sending interest warrants or the principal cheque.
  • Involve your broker/consultant in all your transactions. Do not bypass your broker and invest directly just to earn an extra incentive. A good broker can add value by alerting you about default or downgrade as it his business to keep in constant touch with the market and is generally the first to come to know about any disturbing signals.
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Why you should invest in Fixed Income Securities?
One should invest in Fixed Income Securities for the following reasons
  • Diversification: It is always considered a good strategy to have a percentage of your portfolio investment in Fixed Income instruments. They are safer that equity (stocks) and can provide a decent return on investment.
  • Steady monthly, quarterly or annual income: If you are looking for a steady income you can diversify your investments within the Fixed Income Securities to safeguard your principle and fixed income.
  • Parking excess cash: If you are not sure of what to do with your excess cash, for the time being it is a good idea to invest in fixed income instruments rather that speculating in the stock market or other risky ventures.
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Fixed Income FAQ
Company Fixed Deposit is the deposit placed by investors with companies for a fixed term carrying a prescribed rate of interest.
Interest is paid on monthly/quarterly/half yearly/yearly or on maturity basis and is sent directly to the depositors at their residence or credited to their Bank Account.
No, at the end of deposit period principal is returned to the deposit holder.

Companies registered under Companies Act 1956, such as:

  • Manufacturing Companies
  • Non-Banking Finance Companies
  • Housing Finance Companies
  • Financial Institutions
  • Government Companies


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