Guide to .. Tax Management ,Tax Planning and Tax Saving

 

 

FAQ on Mutual Fund Investment

1.   How to Create Best Mutual Fund Portfolio for Yourself

To create a sensible investment portfolio through mutual fund investment we need keep these 5 rules in mind and these are:

Rule - 1: Know Your Investment Goal

Know Your Investment Goal based on the time frame of your goal, it can be classified as long-term or short-term goals. Goal based investing helps you to draw a proper plan to meet your financial needs within a stipulated time frame.

Rule -2: Know Your Investment Time

Know Your Investment Time frame having a defined time frame for your investments can help you prioritize your goals and helps you stay focused and disciplined.

Rule – 3: Know Your Risk Tolerance

Know Your Risk Tolerance Investing without knowing risk tolerance can give you sleepless nights. Decide your risk-taking ability and stay calm once invested.

Rule – 4: Know Your Asset Allocation

Know Your Asset Allocation It’s necessary to decide Asset Allocation to diversify your investment across Equity, Debt & Gold. Knowing how much to invest across these instruments will help manage risk-reward aptly.

Rule – 5: Know Which Product

Know Which Product to Invest into, invest in a product that suits your investment needs and matches the time horizon of your investment as well as your risk-taking capability.

2.   When to Review Your Mutual Fund Investment Portfolio?

The review of mutual fund portfolio must be done every quarter and following factor should be kept in mind while doing the review of investment portfolio.

1.     Don’t take short term decision in haste

do not take a decision in changing your investment portfolio due to a short term incident because in equity market the volatility remains the integral part and the mutual fund it is supposed to show some time negative return also, take care of long term perspective while evaluating investment portfolio in mutual fund investment.

2.     Comparison of returns with benchmark and peers

while evaluating investment portfolio each scheme of the mutual fund must be compare with the benchmark return and the return of the mutual fund of the same category and then try to evaluate the performance of your scheme and through this exercise it will help you to create a better portfolio.

3.     Portfolio overlap

the aim of investing in different categories such as large cap Mid Cap small cap or Multicap is basically done to provide a better diversification to the investment portfolio of a mutual fund investor and to provide all season return. so that portfolio overlap on the existence of same stocks in two different Mutual Funds in the investment portfolio must not exist and Such overlap of greater than 2 5—30% to be avoided which can help you in great deal in creating a diverse portfolio for long term.

4.     Changes in fund schemes

the mutual funds changes their portfolio depending on the market situation prevailing in the current market some changes can really impact your mutual fund Returns, and also can lead to the portfolio overlap due to this changes these changes must monitor timely and accordingly modification in Portfolio must be made if required.

5.     Change in fund manager or fund objective

these two changes can highly impact the returns of your mutual fund portfolio so the changes in management of the fund manager or the objective of scheme must be review.

3.  When to Sell Your Mutual Fund?

Most common question which I faced from my viewers on YouTube about mutual fund is when to sell the mutual fund?

And I also come across the question that if the market is at all time high then we should redeem all mutual fund investment, Remember before you redeem your mutual fund investment ask yourself that is financial goal is it achieved at if the answer is no then you need not to sell your mutual funds. In case of midcap and small cap funds it’s better to stay away from them when the market is overvalued and is at all time high, at that particular time you can switch to large cap mutual funds or Hybrid funds.

The second most common question which is been asked about selling mutual fund and booking profit or loss is when the mutual fund is giving negative return for more than an year compare to Mutual Fund in the same category. And the answer of this question is in short term the market is always volatile and it is generally are roller coaster ride but equity investment are meant for long term purpose so in long term the equity market is going to go upside, for example we can take the case of 2008 crisis the market was down almost 50%, and almost entire one year from then the market was not performing at that time many Mutual Funds were giving negative returns and the mutual fund investor came out of it but just after that in Same mutual fund had given their lifetime high returns almost greater than 60% — 70% or even some funds were greater than 100%. which were giving negative returns of more than 50% also so keeping a short-term view is not good for investing in equity mutual funds.

Keep in mind that only if your goal is reached or another scenario if your Fund is not performing good continuously for 4 to 6 quarters then you need to sell this mutual funds or other book profit or rebalance your portfolio, else stay invested till your financial goal is reached.

 

4. What are the Growth, Dividend and Dividend Reinvestment options to invest in Debt Mutual Fund?

Basis

Growth Option

Dividend Option

Dividend Re-Investment

Profit Actions

Profits are not paid directly to investors; they are reinvested and the lump sum amount is paid at the end.

Profits are stepped out of your NAV and given to you periodically,

Profits are not paid directly to investors; they reinvested to buy more units for investors

Effect of corn- pounding

As the profits are
reinvested immediately, there’s a benefit of corn- pounding on returns until the maturity period.

A part of the profit is paid out, so compounding effect is not there or is at minimal.

Same as Growth Option

Choice suits

The investors targeting for long term financial goals and looking for long term investment plans should opt for growth option.

In Debt Funds — If you are looking for regular income from Dividends and then you can use this option.

Growth is better as it can help you in better taxation if you stay invested for 3 years. If planning to invest for less than 3 years, then Growth and Dividend reinvestment option doesn’t differ too much in terms of taxation or returns.

Taxation

Only Capital Gain Tax

Capital Gains Tax on gains during redemption Dividends are added as part of your income and taxed as per your tax slab.

Same as Dividend Option

5. What is AUM? Does the AUM of a Mutual Fund matter us?

As we know a Mutual Fund is where several investors who share a common investment objective pool in their money with the sole intention of earning returns. The market value of this pooled money is known as the Asset Under Management of the scheme. It is an indicator of the size and success of the Fund House. Net assets of any scheme gives fair idea of confidence level of investors in the mutual fund scheme.

AUM of a fund house has direct impact on investors profitability. Every fund house charge their investors through Expense Ratio, it is a management fee levied by fund house which is proportional to the fund size. Generally it is observed that barring a few exceptions most fund houses who have higher AUM charge a lower Expense Ratio, thereby increasing profits in the hands of investor.

In Debt Funds, AUM plays more important role as the funds with high AUM have better chances to grab better (Safe & good yielding) Bonds & Debentures. When good companies look to raise money and come up with a Bond or Debenture, then many Debt Funds compete to grab those bonds or debentures due to limited quantity. In such case, funds with high AUM mostly have better bargaining power to grab such good opportunities. Also, high AUM has no impact on fund’s performance in case of Debt Funds.

6. What is a NAV? How is it calculated?

Net asset value (NAV) is a mutual fund's price per unit. In other words, it is the value of a single unit of a mutual fund.

It changes once every working day as the value of the bonds, deposits and stocks the fund holds, changes every working day; except ETF, where the NAV changes real time with the change in markets. It is calculated by dividing the total value of all the securities in its portfolio, minus any liabilities, divided by the total number of units of the mutual fund.

The NAV calculation is important because it tells us how much one share of the fund is worth.

How is NAV calculated?

General Net Asset Value Calculation

If you invest Rs 5,000 in a mutual fund with a net asset value of Rs 500, then you can purchase 10 units of the mutual fund. For example, you put Rs 1 lakh in Mutual Fund Scheme A and Mutual Fund Scheme B. The NAV of mutual fund scheme A is Rs 10 and that of mutual fund scheme B is Rs 20.

You have units of mutual fund scheme allocated as follows: Mutual Fund Scheme A : Rs 1,00,000 / Rs 10 = 10,000 units Mutual Fund Scheme B: Rs 1,00,000 / Rs 20 = 5,000 units.

Daily NAV Calculation

All mutual funds compute the market value of the securities after market hours each day. The mutual fund house deducts all the outstanding liabilities and expenses accordingly to calculate the net asset value (NAV) of the day using the given formula.Net Asset Value = [Assets – (Liabilities + Expenses)] / Number of outstanding units

Assets of a mutual fund scheme are divided into securities and liquid cash. Securities include equity instruments, debentures, bonds, commercial paper and other money market instruments.

The fund manager deducts all liabilities and expenses of managing the fund. You would find the NAV calculated by dividing the combined value of cash and securities in the portfolio of a mutual fund minus requisite liabilities and then dividing by the total number of outstanding units.

7. How does a Mutual Fund work? Are they Safe? Do they Guarantee returns?

Suppose a mutual fund invests in ten bonds and total current market value of all the bought bonds is 1.01 Crore. Out of this, the AMC deducts say, 0.01 Crore for operating the fund (this is known as the expense ratio). So, the net value is 1 crore. Now the AMC will divide this 1 Crore into say, 10,000 parts. These parts are known as units. The cost of one unit is 1Cr/10,000 = Rs. 1000. This is known as the Net Asset Value (NAV) of the mutual fund.

Suppose the AMC has set a minimum investment requirement of Rs. 500. Then if you pay Rs. 500, you will get 0.5 units of the fund. Remember that the cost of one unit is the cost when you made the purchase. Suppose after one year, the NAV has fallen to Rs. 700 per unit and you wish to exit the fund (also known as redemption), then you sell your 0.5 units back to the AMC and get 0.5 x Rs. 700 = Rs. 350 back. So, you invested Rs. 500  and got back Rs. 350 – a loss of 150 over a year. The point is, that you buy units at current NAV and sell units (fully or partially) at current NAV. This is how mutual funds work.

Are Mutual Funds Safe? –

A common pickup line for Sales managers is that Mutual Funds give good returns over the long term. But the truth is, there is no guarantee. Same thing with safety of funds. Your capital will always be at risk. It is just a matter of how big or how small risk are you willing to take. But if you are worried that the AMC will run away with your money? Then no, it is highly unlikely that the AMC will do that as there are enough safeguards implemented by SEBI.

As the above example shows, you buy at current market value and sell at the current market value, so anything can happen in between good returns or losses too. So, it is always advisable to accept and learn to minimize the risks before investing in Mutual Funds. Each different fund categories have different type & level of risk – Liquid, Debt, Equity, Hybrid and Gold. Liquid and Debt Funds carry lower risk than Equity and Gold due to the safety provided by their underlying asset (Bonds, Debentures, T-Bills, CP, CDs etc.). Mostly (except in few cases), capital is safe in Debt funds and Liquid Funds as they invest in safer assets.

8. What is NFO? Should I invest in one?

NFO stands for New Fund Offer, under which a First-Time offer is made by the mutual fund house, to newly introduce a mutual fund in the market. A new fund offer is launched in the market to raise capital from the public to buy securities like shares, govt. bonds, etc. from the market.

Where NFO’s are good option to invest for a Closed End Fund, it is better to avoid the option for Open Ended Actively managed Funds due to following reasons:

1.         They have no proven track record. 

2.         Most of the times such funds come with higher Expense ratio as their initial marketing cost etc. is higher. 

3.         They are not cheaper than already existing funds. This is a myth, that Rs. 10 NFOs are cheaper than their existing peers as the NAV of the later would be higher and hence lesser units would be bought for the same cost. This is totally wrong. Your returns depend only on the percentage growth on NAV, based on the portfolio of that fund. So hypothetically, if there are two funds with exactly same stock portfolio A & B. A is an NFO with NAV of Rs. 10 whereas B has been in the market for 10 years and has NAV of Rs. 200. Then if underlying portfolio increases by 10% in a year, then NAV of A will become Rs. 11 and NAV of B will become Rs. 220. So, no difference in returns. 

4.            NFOs are not like IPOs: In NFO the NAV is fixed at Rs. 10 per unit and is not affected due to the demand or other factors. While in IPO the listing price of the stock depends on the demand and market’s expectation of the company.

 

9. What is a Bond (Fixed Income)?

When you purchase a bond, you effectively are lending a company or the government your money. The bond issuer is the borrower. It agrees to pay whoever holds the bond interest on a regular basis, and then to return the principal on the loan when the bond matures. This can make bonds attractive for people looking for a stable investment.

Unlike a stock where you’re not sure of future cash flows of the company, with bonds you know exactly what they’re going to be.  The only risk is that the issuer ends up defaulting and doesn’t pay the debt. The flip side of bonds’ low risk is that they have less potential than stocks for high returns.

The rate of interest a bond must pay depends in part on interest rates prevalent on the date of issue. So in 2011, when interest rates fixed by RBI were high, new bonds issued at that time gave high rate of return whereas in 2017 when interest rates are relatively lower, new bonds getting issued are offering very low rate of return. Rate of interest is also in part dependent on the creditworthiness of the buyer. That’s why Central Govt securities typically carry the lowest yields in the bond market. Large, stable corporations pay a slightly higher rate. Bonds from companies with poor credit ratings are known as junk or high-yield bonds. Junk bonds pay high rates to compensate for the risk that they will default.

Another variable key is a bond’s maturity date. That’s when the bond pays back its principal. Generally, the farther away the maturity date, the higher the interest a bond must pay.

Except in cases of default, investors know exactly what they can expect to make on a bond so long as they hold it to maturity. But bonds can also be bought or sold on the bond market, which means a bond’s current value if you decided to sell it can fluctuate. For example, when interest rates rise, the value of existing bonds on the market will fall. To understand why this is, imagine you hold a 2% bond and rates rise to 2.5%. With a 2.5% yield now available on the market, no one will want to buy your paltry 2% bond, unless you cut the price. Likewise, bond prices rise when interest rates fall.

If you own bonds through a mutual fund, you don’t have the option of waiting until the bonds in the portfolio mature. You own a constantly changing mix of bonds, so the total return of the fund is determined partly by the daily value of those bonds on the market.

Since bonds are intended to be bought and sold, all the certificates of a bond issue contain a master loan agreement. This agreement between issuer and investor (or creditor and lender), called the “bond indenture” or “deed of trust,” contains all the information you did normally expect to see in any loan agreement, such as :

1)  Amount of the loan : -

The “face amount” “par value” or “principal amount” is the amount of the loan issuer has agreed to repay at the bond’s maturity/

2)  Rate of Interest :-

Bonds are issued with a specified “Coupon” or “Nominal” rate which is the rate of interest.

3)  Schedule or Form of Interest Payments :-

Interest is paid on most bonds at six-monthly or annually intervals, usually on either the fifteenth or thirty of the month.

4)  Term :-

A bond’s “Maturity” or the length of time until the principal is repaid, varies greatly and is mostly more than 5 years. Debt that matures in less than a year is a “money market instrument” – such as commercial paper.

5)  Call features (if any) :-

A “call feature”, if specified, allows the bond issuer to “call in” the bonds and repay them at a predetermined price before maturity.

6)  Refunding :-

If, when bonds mature, the issuer doesn’t have the cash on hand to repay bondholders, it can issue new bonds. This process is called “refunding”.

Let’s see few examples of Bonds issued by different companies recently –

[Bond (Fixed Income) Mutual Fund-1]

There are two dominant issuers of Bonds: Corporates and the government. Both Private and Public Corporations issue bonds as a way to borrow large sums of money for expansion, acquisition or other use. The central government of our country raises funds through the issue of dated securities, which are long term bonds with maturity ranging from 2 years to 30 years and treasury bills, which are short term bonds with the maturity ranging from 91 days to 364 days. These treasury bills are issued through auction carried out by the reserve bank of India. State government raise money through state development loans generally. Local bodies of various states like municipalities also tap the bond market from time to time.

10.  How Bond Market works?

Bonds are simply a way for governments and companies to borrow money. Instead of borrowing money from a bank, a company or government can sell bonds to a large group of investors to raise the funds it needs to operate or grow. Bonds are a simple instrument, which have a fixed coupon rate or interest rate, fixed Maturity Period and Fixed Principal.

Example, if ABC company has issued a bond, then they will mention the Principal Rs 1000, Maturity Period – 7 Years and Interest Rate – 8%/annum. So, you will pay them Rs 1000 for 1 bond and you will get 8% per annum every year for next 7 years and then after 7 years, you will get your Rs 1000 back. Simple!

But what if you don’t want to keep it for 7 years? And want to sell it earlier and here all the complications start. So, Bond Market is like a Stock market where Bonds are bought and sold before expiry and their prices changes frequently. Why?

With bond investing, prices go up and down in response to two factors: changes in interest rates and changes in credit quality. Managing interest rate risk has become the most critical variable in the management of bond portfolios.

Interest Rate Risk

"Interest rate risk," also known as "market risk," refers to the propensity bonds have of fluctuating in price as a result of changes in interest rates.

All bonds are subject to interest rate risk.

Let us suppose you bought a 10-year bond of Face Value Rs 1000, with interest rate 8%. now, after 2 years you now wish to sell your bond but interest rates which other bonds are offering for the same maturity are currently at 10%. How can you convince someone to purchase your bond, with an interest of 8%, when he can buy new bonds with a 10% interest?

Well, there is only one thing you can do: You sell the bond at discount. In fact, the price at which a buyer would buy your bond as readily as a new issue is that price at which your bond would now yield 10%. The price at which you can sell a 1000 Rs bond in such a scenario will be Rs 885. But you will object, if I sell my Rs 1000 bond for approx. Rs 885, I have lost Rs 115 per bond!

That is precisely the point. This is exactly opposite if suppose interest rates would have decreased to 6%, then you could have sold your investment at premium of approx. Rs 1130, a gain of Rs 130 on each bond. Therefore, bond prices have inverse relationship with interest rates. If interest rate increases, bond prices decreases and vice versa.

In the bond investing area, significant changes in the interest rate environment are not hypothetical. During the past decade, swings of 2% have occurred on several occasions over periods of a few weeks or a few months. Here are examples from chart of Indian 10 Year Bond monthly yield -

[Bond (Fixed Income) Mutual Fund-2]-Repeat

With bond investing, the basic principle is that interest rates and prices move in an inverse relationship. When interest rates went from 7.08% to 5.26%, that represented a decrease in yield of over 25%. The price of the bond increased by a corresponding amount. On the other hand, when interest rates increases, then the price of the bond goes down.

Now important thing to note here is that price doesn’t change only when RBI changes interest rates but it changes on a daily basis? Why? Because of the expectation of change based on number of internal & external factors – Inflation figures, Economic Growth figures, Global Liquidity etc.

Inflation:

When the price level rises, each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with surplus funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation.

As a result, with rising inflation, interest rates tend to rise. The opposite happens when inflation declines.

Economic Growth:

If the economic growth of an economy picks up momentum, then the demand for money tends to go up, putting upward pressure on interest rates. Whereas, when Economy slows down, RBI has pressure to decrease interest rate so that loans become cheaper which could increase economic activity.

Global liquidity: 

If global liquidity is high, then there is a strong chance that liquidity will chase higher interest rates in the country and more money flows in, which would put a downward pressure on interest rates.

So, with all these factors and even the different expectations on these factors leads to dynamic bond market which changes every day very similar to how expectation of a good/bad performance of a company changes its stock price daily.

Other way which impacts Bond price is credit quality of the Bond. So, taking the same example, if interest rate has decreased to 6% after 2 years when we want to sell the bond, but the company whose bond we are holding is not performing well and its credit quality is becoming questionable, then in that case we may not be able to demand the premium on our bond and may actually have to sell at discount. So, all these factors keeps the bond market dynamic. Due to these factors, our Debt investments can give us negative returns too.

11.  What is Money Market and what are major Money Market instruments in India?

There are two kinds of markets where borrowing and lending of money takes place between fund scarce and fund surplus individuals and groups. The markets catering the need of short term funds are called Money Markets while the markets that cater to the need of long term funds are called Debt Markets.

The term ‘Money Market’, according to the Reserve Bank of India, is used to define a market where short-term financial assets are traded. These assets are a near substitute for money. So, essentially, the money market is an apparatus which facilitates the lending and borrowing of short-term funds, which are for a duration of under a year. Short maturity period and high liquidity are two characteristic features of the instruments which are traded in the money market. The nature of the money market transactions is such that they are large in amount and high in volume. Thus, the entire market is dominated by few of large players. The key players in the organized money market include Governments (Central and State), Mutual Funds, Corporates, Commercial / Cooperative Banks, Public Sector Undertakings (PSUs), Insurance Companies, Non-Banking Financial Companies (NBFCs) & Discount and Finance House of India (DFHI).

Here are the major Money Market Instruments issued in India –

Treasury Bills (T-Bills)

Issued by the Central Government, Treasury Bills are known to be one of the safest money market instruments available. However, since treasury bills carry zero risk and therefore, the returns one gets on them are not attractive. Treasury bills come with different maturity periods like 3-month, 6-month and 1 year and are circulated by primary and secondary markets.

Certificate of Deposits (CDs)

A Certificate of Deposit (CD) is a money market instrument which is issued in a dematerialised form against funds deposited in a bank for a specific period. Certificates of Deposit are issued by scheduled commercial banks and select financial institutions in India as allowed by RBI within a limit.

Commercial Papers (CPs)

Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities.

Repurchase Agreements (Repo)

Repurchase Agreements: Repurchase transactions, called Repo or Reverse Repo are transactions or short term loans in which two parties agree to sell and repurchase the same security. They are usually used for overnight borrowing. Repo/Reverse Repo transactions can be done only between the parties approved by RBI and in RBI approved securities viz. GOI and State Govt Securities, T-Bills, PSU Bonds, Corporate Bonds etc. Under repurchase agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date at a predetermined price. Such a transaction is called a Repo when viewed from the perspective of the seller of the securities and Reverse Repo when viewed from the perspective of the buyer of the securities.

Banker's Acceptance (BA)

Banker's Acceptance or BA is basically a document promising future payment which is guaranteed by a commercial bank. The bill may be drawn, for example, by an exporter on the importer who in turn gets guarantee by their country’s commercial bank and sold by exporter on the open market at a discount to cash in the money immediately.

Similar to a treasury bill, Banker’s Acceptance is often used in money market funds and specifies the details of the repayment like the amount to be repaid, date of repayment and the details of the individual to which the repayment is due. Banker’s Acceptance features maturity periods ranging between 30 days up to 180 days. Bankers acceptances have low credit risk because they are backed by the importer, the importer's bank, and the imported goods

Call/Notice Money

It means a loan for very short period i.e., one to fourteen days. The loans are repayable on demand at the option of either the lender or the borrower. Call money is money at call. Call money market is a market where short-term surplus funds of commercial banks, and other financial institutions, are traded. The participants, usually, borrow and lend call/ notice money for one day/ for a period up to 14 days. The call money market is the highly liquid market and there is no collateral involved, and accounts for a large share of the total turnover of the money market. Overnight Debt Funds invest their large portfolio in this instrument.

Commercial Bills

Commercial bills arise out of trade transactions. When goods are sold on credit the seller draws a bill on the buyer for the due amount. The buyer accepts it agreeing to pay the amount after specific period to the person mentioned in the bill or to the bearer of the bill. It is drawn for a short period ranging from three to six months. These bills are transferable by endorsement and delivery and can be discounted or rediscounted. In a bill market the bill of exchanges are bought and sold.

Commercial banks, co-operative banks, financial institutions, mutual funds etc. can participate in the bill market. Thus, the seller can get payment immediately by discounting the bills with commercial banks or other financial intermediaries. At maturity date the intermediary claims the amount of money from the person who has accepted the Bill.

Very similar concept as Banker’s acceptance. Banker’s acceptance is majorly used for export import transactions whereas commercial bills is used for other local transactions.

12. What is Corporate Debt & Type of Corporate Debt?

Corporate debt is the money borrowed by the companies to serve their financial needs, that they are unable to meet otherwise. Companies wanting to borrow money can resort to loans and other functional options. They can explore other debt types such as commercial paper and bonds. Short-term corporate debt is issued as commercial paper whereas, long-term debt is issued as bonds. Bonds allow companies to raise funds by selling a repayment promise to interested investors. Institutions and individual investment organizations can procure bonds that typically come with a predefined interest rate, or coupon. If an entity wants to raise 10 lacs to purchase new machinery, for instance, it can provide the public with 1,000 bonds each worth rupees 1,000. Once individuals or other companies purchase the bonds, the holders are guaranteed a face value on a given date, commonly known as the maturation date. This amount is in addition to regular interest on the bond throughout the period the bond is active.

Bonds work on a similar principle to that of conventional loans. However, a company is the one borrowing while investors are either creditors or lenders. 

Type of Corporate Bonds

Based on Issuer

Issuers of Corporate Bonds can be broadly classified in following classes:

  • Bonds issued by Local Bodies 
  • Bonds issued by Public Sector Units 
  • Bonds issued by Financial Institutions 
  • Bonds issued by Banks 
  • Bonds issued by Corporates 

Based on Maturity Period

Short Term Maturity:

Security with maturity period less than one year. Medium Term: Security with maturity period between 1year and 5 year. Long Term Maturity: Such securities have maturity period more than 5 years

Perpetual:

Security with no maturity. Currently, in India Banks issue perpetual bond.

Based on Coupon

Fixed Rate Bonds:

Have a coupon that remains constant throughout the life of the bond.

Floating Rate Bonds:

Coupon rates are reset periodically based on benchmark rate.

Zero-coupon Bonds:

No coupons are paid. The bond is issued at a discount to its face value, at which it will be redeemed. There are no intermittent payments of interest 

Based on Option

Bond with call option:

This feature gives a bond issuer the right, but not the obligation, to redeem his issue of bonds before the bond's maturity at predetermined price and date.

Bond with put option:

This feature gives bondholders the right but not the obligation to sell their bonds back to the issuer at a predetermined price and date. These bonds generally protect investors from interest rate risk. 

Based on redemption

Bonds with single redemption:

In this case principal amount of bond is paid at the time of maturity only.

Amortising Bonds:

A bond, in which payment made by the borrower over the life of the bond, includes both interest and principal, is called an amortizing bond.

13. What is Commercial Paper (CP)?

Commercial Paper (CP) is an unsecured and negotiable money market instrument issued in the form of a promissory note issued by companies to raise funds generally for a time period up to one year. 

CPs are issued by highly rated corporate entities to raise short-term funds for meeting working capital requirements directly from the market instead of borrowing from banks. CPs are not usually backed by any form of collaterals and are allowed to be issued only by corporate with high quality debt ratings. The issue of CP seeks to by-pass the intermediary role of the banking system. CPs have been introduced in the Indian market so as to provide a diversified source of funding to the borrowers as well as an additional investment option to the investors.

CPs usually feature a fixed maturity period which can range anywhere from 1 day up to 270 days. Highly popular in countries like Japan, UK, USA, Australia and many others, Commercial Papers promise higher returns as compared to treasury bills and are automatically not as secure in comparison. Commercial papers are actively traded in secondary market.

All CP issuers have to get credit rating from leading organizations. Here are few recent examples of CP issued –

[Bond (Fixed Income) Mutual Fund-3]

14. What is Certificate of Deposits (CDs)?

CDs are a form of fixed term-deposit which have a fixed interest rate and are accepted by commercial banks. CDs are usually issued in Demat form or as a Promissory Note.

All scheduled banks except Regional Rural Banks (RRBs) and Co-operative banks are eligible to issue CDs. They can be issued to individuals, corporates, trusts, funds and associations.

The Certificates of deposits (CDs) were introduced in June, 1989 with the primary objective of providing a wholesale resource base to banks at market related interest rates. The instrument was effectively used to cover certain asset sources and has since emerged as instrument for effective asset-liability management. First announced in 1989 by RBI, Certificate of Deposits have become a preferred investment choice for organizations in terms of short-term surplus investment as they carry low risk while providing interest rates which are higher than those provided by Treasury bills. Certificate of Deposits are also relatively liquid, which is an added advantage, especially for issuing banks. Like treasury bills, CDs are also issued at a discounted price and their tenor ranges between a span of 7 days up to 1 year. However, banks issue Certificates of Deposits for durations ranging from 3 months, 6 months and 12 months. They can be issued to individuals (except minors), trusts, companies, corporations, associations, funds, non-resident Indians, etc.

[Bond (Fixed Income) Mutual Fund-4]

15.  What is Treasury Bill (T-bills)?

Treasury Bills are basically instruments for short term borrowing issued by the Central Government. They have maturities of less than 1 year and are part of money market in India.

Features of T-bills:

  • T-bills are issued only by Central Government. 
  • They are used by Government to manage their short term liquidity. 
  • They have assured yield and negligible risk of default. 
  • They are issued in primary auction conducted by RBI on behalf on Government of India. 
  • T-bills are issued at a discount and redeemed at par.

 Suppose a Rs.100 91 day T-bill is issued at Rs.98.2 i.e., at discount. After maturity, investor will get Rs.100 as maturity of each bill. So, Rs.1.8 will be the interest rate. This interest rate or discount rate is market driven and is decided in the scheduled auction.

At present, the Government of India issues three types of treasury bills through auctions, namely,

  • 91-day, 
  • 182-day and 
  • 364-day. 

Here are examples of recently issued Bills -

[Bond (Fixed Income) Mutual Fund-5]

16. What are NCDs (Non-Convertible Debentures)?

Non-convertible debentures (NCDs) are fixed income instruments where you are promised a certain interest for a fixed tenure. It is a type of Corporate debt where companies issue NCDs when they want to raise money for various needs such as expansion. The NCD is a promise that the company will pay back the money at a promised interest rate. It is closed-ended debt instrument, which means it is available for subscription only for a particular period. The main attraction of NCDs was high return to investors in comparison to other fixed income instruments like bank deposits.

Why it is call Non-convertible? –

There are Convertible debentures too which mean after the specified time, these debentures are converted into shares (stocks) of the company. Up to that conversation, you will enjoy the fixed specified coupon (interest rate) on such debentures. After that, your earnings depends on price appreciation of the stock or the dividend income you receive (if the company declares it). Non-Convertible Debentures, which we are discussing here, on the other hands, will never be converted into shares (stocks) of the company. Investors who invest in such non-convertible debentures will enjoy fixed interest rate up to maturity and after that return of principal (exactly like Bank FDs).

An NCD can either be secured or unsecured. A secured NCD is backed by the issuing company’s assets. This means that the company has to fulfil its debt obligation whatsoever. However, that’s not the case for unsecured NCDs. This makes secured NCDs safer since they have a lower default risk.

Every company that seeks to raise money through an NCD is rated by agencies such as Fitch Ratings, CRISIL, ICRA and CARE. These rating agencies rate the company based on its ability to service its debt on time. So, a lower rating means a higher credit risk. Few recently launched NCDs –

17. How are Debt Mutual Funds Taxed?

From taxation purpose, all the funds which invest less than 65% in Equity are considered as Debt Funds. So many hybrid funds categories like Conservative Hybrid Fund and Capital Protection Funds are taxed as Debt Funds only. Even International Funds are taxed as Debt funds only.

Short-Term Capital Gain- 

When Debt Mutual Funds are sold within 36 months from the date of purchase, the profit or loss on redemption is known as Short-Term Capital Gain or Loss (as the case may be). Short Term Capital Gain is taxable as per the normal tax slab rate and indexation benefit is not available for the same.

Example:

Mr. Ayush purchased Debt Mutual Fund Units on 15.06.2016 for ₹ 1,00,000. The said units were sold on 20.02.2019 for ₹ 1,26,000.

Now, MF units are held for less than 36 months before the sale date. Therefore, it will be considered as Short- term capital asset. Short Term Capital Gain (STCG) will be calculated as below-

Particulars

Reference

Amount (Rs.)

Sale Value of Debt Mutual Funds

A

1,26,000

Purchase Value of Debt MF

B

1,00,000

Short Term Capital Gain (STCG)

C = A - B

 26,000

Now here, STCG shall be taxed at a normal tax slab rate. So, if you tax slab is 30%, your will have to pay 30%* 26000 = 7800 as capital gain tax.

Long-Term Capital Gain-

When Debt Mutual Funds are sold on or after 36 months from the date of purchase, the profit or loss on redemption is known as Long-Term Capital Gain or Loss (as the case may be). Long-Term Capital Gain on redemption of Debt funds is taxable @ 20%. Indexation benefit is available in case of LTCG.

Example:

Mr. Ayush purchased Debt Mutual Fund Units on 21.04.2014 for 2,75,000. The said units were sold on 17.10.2018 for 4,50,000. Calculate Capital Gain considering CII (Cost Inflation Index) of FY 2014-15 as 240 and CII of FY 2018-19 as 280.

Now, MF units are held for more than 36 months before the date of Redemption. Therefore, it will be considered as Long-Term capital asset. For calculating LTCG, we first need to calculate the indexed cost of acquisition.

Calculation of Indexed Cost of Acquisition

Particulars

Reference

Amount

Cost of acquisition (Purchase cost)

A

2,75,000

CII of FY 2014-15

B

240

CII of FY 2018-19

C

280

Indexed Cost of Acquisition

D = A x C I B

3,20,833

The indexed cost of acquisition calculated above, shall be reduced from the amount of redemption.

Calculation of Long-Term Capital Gain (LTCG)

Particulars

Reference

Amount (Rs.)

Redemption Value of Debt Mutual Fund

A

4,50,000

Indexed cost of Acquisition (as calculated above)

B

3,20,833

Long Term Capital Gain (LTCG)

C = A - B

1,29,167

Capital Gain tax irrespective of Tax slab will be 20%1 29,167 = 25,833.40

18. What are Expense Ratios of Debt Mutual Funds?

Like any business that charges you for their services, mutual funds, too charge a fee for managing your money. This includes the fund management fee, agent commissions, registrar fees, and selling and promoting expenses. All this falls into a single basket called total expense ratio (TER) that is disclosed on a monthly basis and is expressed as an annualized percentage of the fund’s net assets. TER is deducted every day from fund’s NAV. So the returns which you see on websites and fund’s documents are all post Expense Ratio returns.

Each fund scheme has two different plans based on TER - Direct & Regular. Only difference between these two plans is different TER.

Regular plan has higher TER as it includes distributor’s commission too. If you are buying Mutual Funds through Distributors or Bank websites, you will only see Regular plan option for investments. Example HDFC Corporate Bond TER of Regular plan is 0.6%.
Direct Plan has lower TER as distribution commission is not deducted in this plan. These plans are offered by various websites & apps these days like Paytm money, Groww, Kuvera, etc. Example, HDFC Corporate Bond TER of Direct plan is 0.3%. So, in Direct plan, you will get 0.3% returns more every year.

Expense Ratio of Debt Mutual Funds vary a lot and should be always an important factor in fund’s selection.


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